23 Things They Don't Tell You About Capitalism

The microfinance industry has always boasted that its operations remain profitable without government subsidies or contributions from international donors, except perhaps in the initial teething phase. Some have used this as evidence that the poor are as good at playing the market as anyone else, if you will just let them. However, it turns out that, without subsidies from governments or international donors, microfinance institutions have to charge, and have been charging, near-usurious rates. It has been revealed that the Grameen Bank could initially charge reasonable interest rates only because of the (hushed-up) subsidies it was getting from the Bangladeshi government and international donors. If they are not subsidized, microfinance institutions have to charge interest rates of typically 40–50 per cent for their loans, with rates as high as 80–100 per cent in countries such as Mexico. When, in the late 1990s, it came under pressure to give up the subsidies, the Grameen Bank had to relaunch itself (in 2001) and start charging interest rates of 40–50 per cent.

With interest rates running up to 100 per cent, few businesses can make the necessary profits to repay the loans, so most of the loans made by microfinance institutions (in some cases as high as 90 per cent) have been used for the purpose of ‘consumption smoothing’ – people taking out loans to pay for their daughter’s wedding or to make up for a temporary fall in income due to the illness of a working family member. In other words, the vast bulk of microcredit is notused to fuel entrepreneurship by the poor, the alleged goal of the exercise, but to finance consumption.

More importantly, even the small portion of microcredit that goes into business activities is not pulling people out of poverty. At first, this sounds inexplicable. Those poor people who take out microcredit know what they are doing. Unlike their counterparts in rich countries, most of them have run businesses of one kind or another. Their business wits are sharpened to the limit by their desperation to survive and sheer desire to get out of poverty. They have to generate very high profits because they have to pay the market rate of interest. So what is going wrong? Why are all these people – highly motivated, in possession of relevant skills and strongly pressured by the market – making huge efforts with their business ventures, producing such meagre results?

When a microfinance institution first starts its operation in a locality, the first posse of its clients may see their income rising – sometimes quite dramatically. For example, when in 1997 the Grameen Bank teamed up with Telenor, the Norwegian phone company, and gave out microloans to women to buy a mobile phone and rent it out to their villagers, these ‘telephone ladies’ made handsome profits – $750–$1,200 in a country whose annual average per capita income was around $300. However, over time, the businesses financed by microcredit become crowded and their earnings fall. To go back to the Grameen phone case, by 2005 there were so many telephone ladies that their income was estimated to be around only $70 per year, even though the national average income had gone up to over $450. This problem is known as the ‘fallacy of composition’ – the fact that some people can succeed with a particular business does not mean that everyone can succeed with it.

Of course, this problem would not exist if new business lines could be constantly developed – if one line of activity becomes unprofitable due to overcrowding, you simply open up another. So, for example, if phone renting becomes less profitable, you could maintain your level of income by manufacturing mobile phones or writing the software for mobile phone games. You will obviously have noticed the absurdity of these suggestions – the telephone ladies of Bangladesh simply do not have the wherewithal to move into phone manufacturing or software design. The problem is that there is only a limited range of (simple) businesses that the poor in developing countries can take on, given their limited skills, the narrow range of technologies available, and the limited amount of finance that they can mobilize through microfinance. So, you, a Croatian farmer who bought one more milk cow with a microcredit, stick to selling milk even as you watch the bottom falling out of your local milk market thanks to the 300 other farmers like you selling more milk, because turning yourself into an exporter of butter to Germany or cheese to Britain simply isn’t possible with the technologies, the organizational skills and the capital you have.

No more heroes any more

Our discussion so far shows that what makes the poor countries poor is not the lack of raw individual entrepreneurial energy, which they in fact have in abundance. The point is that what really makes the rich countries rich is their ability to channel the individual entrepreneurial energy into collective entrepreneurship.