As is well known, the microfinance model started out in 1970s Bangladesh as a small village-based anti-poverty programme managed by Muhammad Yunus, the Bangladeshi economist who went on to be co-recipient of the 2006 Nobel Peace Prize along with the iconic Grameen Bank that was his inspiration. With decisive support from the US government through its USAID aid assistance arm and from the World Bank too, Grameen Bank-style microfinance institutions were soon getting a firm foothold in many other developing countries, and especially in Latin America. It helped that Peruvian economist Hernando de Soto was famously making grandiose claims to the effect that facilitating more informal microenterprises would actually be the key to reducing poverty and social exclusion in Latin America (1). Thanks to the growth of BancoSol and other for-profit microfinance institutions, moreover, Bolivia was soon being feted as the global role model for commercialised microfinance. By the mid-2000s the microfinance industry was at the peak of its power and influence in Latin America and globally. With so many of Latin America’s poor now very easily able to get involved in establishing or expanding simple income-generating projects, it was seen as a slam dunk conclusion to very many that the new millennium would see an historically unparalleled ‘bottom-up’ boost to economic and social development. And then it all went spectacularly wrong.
It is widely accepted that the initial catalyst that began the global reassessment, if not downfall, of the microfinance model was the 2007 Initial Public Offering (IPO) of Banco Compartamos in Mexico, an event that almost accidentally revealed massive profiteering and unethical behaviour on the part of senior managers rather than any evidence whatsoever of real progress in poverty reduction. It soon became clear that what was uncovered in the Banco Compartamos scandal was not a rarity at all, as many microfinance supporters reflexively claimed, but pretty much the industry norm: since 1990 the microfinance sector has been increasingly marked out by spectacular levels of Wall Street-style greed, profiteering, and client abuse (2). At the same time, a growing number of economists began to argue that the microfinance model actually represents an ‘anti-developmental’ policy intervention (3). This ‘anti-developmental’ contention was then quickly backed up by a number of high-profile donor-funded independent expert-led systematic reviews which found that there was actually no solid empirical evidence to confirm that microfinance had had a net positive impact on poverty (4). Even worse, starting with Bolivia in 1999-2000, and then on to Nicaragua, Pakistan, Morocco, Bosnia and, quite spectacularly, in Andhra Pradesh state in India (5), the microfinance sector became inextricably linked to hugely destructive sub-prime-style ‘boom-to-bust’ episodes right across the globe.
Unfortunately, therefore, the past thirty years has actually shown the microfinance model to be part of the problem holding back sustainable poverty reduction in Latin America, and not the solution. It turns out that microfinance has largely been driven forward by nothing more than egregious hype, fraudulent PR campaigns, dodgy impact evaluations, wilfully flawed academic research outputs, unwise celebrity support, and a constant stream of faith-healing-like pronouncements from Muhammad Yunus, Hernando de Soto and their acolytes.
Fundamental flaws in Bolivia
Perhaps nowhere have the fundamental flaws in the microfinance model been as awkwardly exposed in practise as in Bolivia, one of Latin America’s poorest and most under-developed countries. For many years Bolivia’s microfinance experience was paraded far and wide as the most important example of the enormous benefits that the commercialised microfinance model can supposedly deliver for the poorest communities (6). This claim has always been palpable nonsense. First, precisely because Bolivia’s scarce financial resources have since the 1980s increasingly been intermediated through microfinance institutions into simple microloans supporting informal microenterprises, self-employment ventures and postage stamp-sized farming units, the end result has been to progressively deindustrialise, infantilise and informalize the Bolivian economy. This trajectory directly reduced Bolivia’s longer-term chances of making progress across a range of crucial categories, notably poverty reduction. Sadly, after making some important progress under the import-substitution industrialisation (ISI) model that prevailed in Latin America in the 1950s and 1960s, the Bolivian economy was essentially assisted by the microfinance industry to abandon this gradual forward momentum and effectively ‘develop backwards’. Thankfully, after years of slavish support for the microfinance idea, this fundamental flaw in the microfinance model is, finally, being more widely recognised in Bolivia for the enormous damage that it has caused (7).
Moreover, it is not just in Bolivia where greater reflection is causing a reassessment of the microfinance model. For example, the Inter-American Development Bank (IDB) has quite dramatically revised the core narrative as to why Latin America has been bedevilled – at least until quite recently – by spectacularly high levels of poverty, inequality and deprivation. In its 2010 flagship report, the IDB showed that this situation arose because far too much of Latin America’s scarce capital resources (especially savings and remittances) had been channelled into low-productivity microenterprises and self-employment, and far too little had gone into the much more productive, innovative and job-creating SMEs and larger firms. For an institution with a long history of supporting microfinance programs, the IDB’s astonishing conclusion was that (8), ‘unlike other regions of the world, the overwhelming presence of small companies and self-employed workers (in Latin America) is a sign of failure, not of success‘ (my italics). The most important drawback to the microfinance model is thus very simple: the programmed output of microfinance – informal microenterprises, tiny self-employment ventures and subsistence farming plots – is completely the wrong foundation a country needs in order to begin to sustainably escape poverty and deprivation. Yet with the volume of microfinance growing in recent years right across Latin America, and lending to more substantive enterprises increasingly being ‘crowded out’, this fundamental structural problem is actually being exacerbated.
It is also now more widely realised that cramming more and more informal microenterprises into the same local economic space creates a number of blowback effects that tend to swamp any potentially positive impacts. For a start, more microenterprises typically leads on to ‘displacement’, which is where new microenterprises only survive by tapping into the local demand that up to then was supporting incumbent microenterprises. Incumbent microenterprises, which typically also involve equally poor individuals, thus suffer through no fault of their own. There is simply no economic law that means a microfinance-induced additional supply of simple goods and services will automatically create the required additional local demand to absorb it. Compounding the problem of displacement is the related problem of microenterprise failure. Even more than small or medium businesses, microenterprises are ‘poverty-push’ by nature, and so we tend to see a very high failure rate of such business units. This means, first of all, that into the longer term microfinance generates far less sustainable job creation than is typically advertised. However, failure also means the poor often experience the dangerous loss of important assets. Households first draw down family savings and divert remittance income to try to repay their microloan. If this is not enough, there is then the need to sell off important assets (often at fire-sale prices), such as equipment, machinery, motor vehicles, housing and land. On losing these assets, poor households all too often plunge into deeper, and often irretrievable, poverty. The result of more microfinance-induced entry and competition in the microenterprise sector is actually that incomes of the poor tend to decline (9), intra- and inter-community solidarity are destroyed (10) and so such investments in the poor are effectively wasted (11).
A third fundamental problem is that the vast bulk of microfinance is not used to fuel microenterprise development at all, but actually goes to support simple consumption spending. Thanks to easy availability but with interest rates typically very high – the aforementioned Mexican microfinance bank, Compartamos, charges its poor clients an annual interest rate of 195% – we increasingly find that the poor all too easily end up spending a large part of their meagre incomes on interest repayments. Yet like a gambler who continually seeks out the ‘one big win’ that will make him rich and, crucially, will also repay all the previous debts incurred in the search for success, all too often the poor continue to access more and more microloans in a desperate attempt to find some minor exit from poverty today, knowing that they might not survive into the next year no matter what they do. This well-known psychology also helps to account for the dramatic emergence of very specific Ponzi-style dynamics in a growing number of Latin American countries, characterised by the poor gradually becoming trapped into a desperate cycle of accessing more new microloans simply to repay existing microloans.
The final problem with the microfinance model relates specifically to the commercialisation of microfinance concept that was the international donor community’s primary goal in the 1990s. As the nominated pioneer country for commercialised microfinance, it was almost inevitable that Bolivia would encounter the first of what was to be a series of catastrophic ‘microfinance meltdowns’. In Bolivia this was the 1999 over-indebtedness crisis which plunged the economy into a deep crisis. At the time microfinance supporters described this episode as a ‘one-off’ aberration caused by factors supposedly unrelated to the core operation of Bolivia’s microfinance model, such as unfair competition coming from a large microfinance institution coming to Bolivia from Chile. However, castigating competition as the ‘bad guy’ seems strange when the previous twenty years had been spent arguing that ‘more competition’ was one of the principal benefits of commercialised microfinance! Awkwardly, thanks to ‘more competition’ leading to a sub-prime-style orgy of over-lending to manifestly unsuitable clients, the microfinance sector in Nicaragua was similarly driven to near collapse in 2010. Today, moreover, there is growing evidence that unsustainable profit-driven growth in the microfinance sector marks out the situation in Mexico, Peru and Colombia, meaning that further destructive ‘microfinance meltdowns’ are now ominously looming on the horizon. Meanwhile, and yet another obvious parallel to the economically and socially destructive greed-driven practices pioneered by Wall Street and the City of London (12), we have to continue to believe that those providing a virtually unlimited supply of microloans to the poor, and who are thereby amassing often stratospheric fortunes for themselves and their investors, are nevertheless doing this out of a selfless commitment to ‘helping the poor’.
All told, those behind the deliberately created myths surrounding the microfinance model in Latin America, just as much as everywhere else around the globe, appear to be responsible for one of the most important policy blunders in recent economic and social history.
*Freelance consultant in local economic development, Visiting Professor of Economics at the University of Juraj Dobrila Pula, Croatia, and author of ‘Why Doesn’t Microfinance Work? The Destructive Rise of Local Neoliberalism’ published by Zed Books in 2010.
(1) Hernando de Soto (1989). The Other Path: The Invisible Revolution in the Third World. London: I.B.Taurus.
(2) Hugh Sinclair (2012) Confessions of a Microfinance Heretic: How Microlending Lost Its Way and Betrayed the Poor. San Francisco: Berrett-Koehler
(3) For example, see Milford Bateman (2010) Why Doesn’t Microfinance Work? The Destructive Rise of Local Neoliberalism. London: Zed Books. See also, Milford Bateman and Ha-Joon Chang. (2012) ‘Microfinance and the Illusion of Development: from Hubris to Nemesis in Thirty Years’, World Economic Review, Volume 1(1).
(4) See Maren Duvendack, R Palmer-Jones JG Copestake, L Hooper, Y Loke and N Rao (2011) What is the evidence of the impact of microfinance on the well-being of poor people? London: EPPI-Centre, Social Science Research Unit, Institute of Education, University of London.
(5) See Ramesh Arunachalam (2011). The Journey of Indian Micro-Finance: Lessons for the Future. Chennai: Aapti Publications.
(6) See Elizabeth Rhyne (2001). Mainstreaming Microfinance: How lending to the poor began, grew, and came of age in Bolivia, West Hartford, CT: Kumarian Press.
(7) After a public lecture by the author at the Vice President’s residence in La Paz, Bolivia, on May 10th 2012, the local media came alive with critical commentary on the microfinance model as perhaps never before, and from some quite unexpected sources too, such as traditionally right-wing Chamber of Commerce supporters and officials. For example, see ‘Thank you, Mr Bateman’, Pagina Siete, 10th June, 2012. Go tohttp://www.paginasiete.bo/Suplementos/Ideas/2012-06-10/Destacados/04ideas-001-0610.aspx (accessed on July26th, 2012).
(8) See IDB (2010). ‘The Age of Productivity: Transforming Economies from the Bottom-Up’. Washington DC: IDB.
(9) In 2009, for example, the ILO argued against further stimulation of the informal microenterprise sector, since ‘As was the case in previous crises, this could generate substantial downward pressure on informal-economy wages, which before the current crisis were already declining’ – see page 8 (ILO). 2009. The Financial and Economic Crisis: A Decent Work Response, Geneva: ILO.
(10) See Mike Davis (2006). Planet of Slums. London: Verso.
(11) Milford Bateman, Juan Pablo Duran Ort?z., and Dean Sinkovi?. (2011). ‘Microfinance in Latin America: the case of Medellín in Colombia’ in: Milford Bateman. (Ed). Confronting Microfinance: Undermining Sustainable Development. Sterling, VA: Kumarian Press.
(12) See Gary Dymski (2009). ‘Racial Exclusion and the Political Economy of the Subprime Crisis’, Historical Materialism 17, 149–179.