23 Things They Don't Tell You About Capitalism

So we are faced with an apparent puzzle. Compared to the rich countries, we have far more people in developing countries (in proportional terms) engaged in entrepreneurial activities. On top of that, their entrepreneurial skills are much more frequently and severely tested than those of their counterparts in the rich countries. Then how is it that these more entrepreneurial countries are the poorer ones?

Great expectations – microfinance enters the scene

The seemingly boundless entrepreneurial energy of poor people in poor countries has, of course, not gone unnoticed. There is an increasingly influential view that the engine of development for poor countries should be the so-called ‘informal sector’, made up of small businesses that are not registered with the government.

The entrepreneurs in the informal sector, it is argued, are struggling not because they lack the necessary vision and skills but because they cannot get the money to realize their visions. The regular banks discriminate against them, while the local money-lenders charge prohibitive rates of interest. If they are given a small amount of credit (known as a ‘microcredit’) at a reasonable interest rate to set up a food stall, buy a mobile phone to rent out, or get some chickens to sell their eggs, they will be able to pull themselves out of poverty. With these small enterprises making up the bulk of the developing country’s economy, their successes would translate into overall economic development.

The invention of microcredit is commonly attributed to Muhammad Yunus, the economics professor who has been the public face of the microcredit industry since he set up the pioneering Grameen Bank in his native Bangladesh in 1983, although there were similar attempts before. Despite lending to poor people, especially poor women, who were traditionally considered to be high-risk cases, the Grameen Bank boasted a very high repayment ratio (95 per cent or more), showing that the poor are highly bankable. By the early 1990s, the success of the Grameen Bank, and of some similar banks in countries such as Bolivia, was noticed, and the idea of microcredit – or more broadly microfinance, which includes savings and insurance, and not just credit – spread fast.

The recipe sounds perfect. Microcredit allows the poor to get out of poverty through their own efforts, by providing them with the financial means to realize their entrepreneurial potential. In the process, they gain independence and self-respect, as they are no longer relying on handouts from the government and foreign aid agencies for their survival. Poor women are particularly empowered by microcredit, as it gives them the ability to earn an income and thus improve their bargaining positions vis-à-vistheir male partners. Not having to subsidize the poor, the government feels less pressure on its budget. The wealth created in the process, naturally, makes the overall economy, and not just the informal sector entrepreneurs, richer. Given all this, it is not a surprise that Professor Yunus believes that, with the help of microfinance, we can create ‘a poverty-free world [where the] only place you can see poverty is in the museum’.

By the mid 2000s, the popularity of microfinance reached fever pitch. The year 2005 was designated the International Year of Microcredit by the United Nations, with endorsements from royalty, like Queen Rania of Jordan, and celebrities, like the actresses Natalie Portman and Aishwarya Rai. The ascendancy of microfinance reached its peak in 2006, when the Nobel Peace Prize was awarded jointly to Professor Yunus and his Grameen Bank.

The grand illusion

Unfortunately, the hype about microfinance is, well, just that – hype. There are growing criticisms of microfinance, even by some of its early ‘priests’. For example, in a recent paper with David Roodman, Jonathan Morduch, a long-time advocate of microfinance, confesses that ‘[s]trikingly, 30 years into the microfinance movement we have little solid evidence that it improves the lives of clients in measurable ways’.[2] The problems are too numerous even to list here; anyone who is interested can read the fascinating recent book by Milford Bateman, Why Doesn’t Microfinance Work?[3] But those most relevant to our discussion are as follows.