Below the Fold: Buddy, Can You Spare a Dime? On Microfinance and a Nobel Prize

11620239Nine days ago, the Nobel Peace Prize was awarded to Muhammad Yunus, Bangladeshi economist and spark plug of the worldwide microcredit movement. In a nutshell, community organizations and non-profit organizations loan poor people bits of money so that they can start or improve their tiny businesses. Microcredit is widespread in poor and not so poor countries. In 2005, 100 million people received loans via 3000 lenders in 130 countries.

Praise for the microcredit movement is well nigh universal. The Nobel committee in awarding the prize noted that “microcredit has proved to be an important liberating force in societies where women in particular have to struggle against repressive social and economic conditions.” (New York Times, October 14, 2006, p.1) The United Nations designated 2005 as the “year of microcredit.” Former President Clinton began funneling development assistance via nongovernmental organization into microcredit, and the present regime devotes the majority of its foreign monies to microcredit lending. Senator Clinton announced on September 22 that Citicorp would lend $100 million to microlenders worldwide. A Swiss investment bank has floated bonds for microcredit institutions based on the securitization of their loan portfolios. Big money managers are not far behind: TIAA-CREF, the pension and annuity people for college teachers, will invest another $100 million in loans to microcredit agencies.

Professor Yunus himself deserves all credit for converting an astonishingly simple observation into an ambitious and extensive self-help scheme. He realized that the homely truth that the essence of poverty is the absence of money, and because banks don’t lend money to people without it, the poor were locked out of credit markets. They were doomed, as Max Weber observed about nineteenth Century Naples, to spend their days trading the same gold piece back and forth, ending each day just as poor as when they started. Yunus in an interview with the Times recounts his eureka experience. In 1976, he emptied his pockets of $27 dollars on the spur of the moment to 42 Bangladeshi villagers who asked for help. To his surprise, the villagers immediately made money on his money, and repaid him as if his charity had been a loan. “If you can make so many people happy with such a small amount of money,” Yunus recalled that day for the Times, ‘why shouldn’t you do more of it?”

And just so, the Grameen Bank in Bangladesh under Professor Yunus’ tutelage, was born. The bank has loaned money to more than 7 million people, and has focused primarily but not exclusively on serving women. The average loan now is $130 dollars. Typically, loans are made to a group of 5 women whose co-involvement provides the bank with additional security that the loan will be repaid. With high repayment rates, investment bankers are seeing banks like the Grameen as a good business risk. As the Swiss banker noted in an interview with the Financial Times: “We believe that although the microfinance sector is small today, it will become an established asset class in the future.”

With Citibank, Swiss bonds and a US pension fund leading the way, it is likely that via your savings and pension and mine, we will be a beneficiary of microcredit, albeit as a lender. What is your money and my money channeling or to be channeled through microcredit doing or not doing for the world’s poor?

Though Yunus has performed a modern version of the loaves the fishes, there is increasing acknowledgement that microcredit is not a panacea for world poverty. The World Bank and even the New York Times in its report on Professor Yunus admits it. But if we press a bit further we find that microcredit is not helping the really poor – the 1.5 billion one dollar a day poor, and it is not clear what good it is doing for the 3 billion two dollar a day poor. Both groups need money, not loans. The International Fund for Agricultural Development in 2001 explains:

Microfinance alone is not a magic bullet for poverty reduction… the claims that microfinance assists ‘the poorest’ and ‘the poorest of the poor’ are unfounded within national contexts. Microfinance institutions virtually never work with the poorest … and many microfinance institutions have high proportions of clients who are non-poor, using national poverty lines.

Who then does it help, and how? It helps people in poor surroundings who are already just a little or more ahead of their fellows. Let’s not exaggerate, but given the universal acclaim accorded microcredit, it is important to note that it mostly enables recipients to do just a tad better than before. Call it the two-rutabaga problem. Suppose you start a little stand in a local market selling the spare rutabaga from your garden. A microcredit loan might help you to acquire another, and you sell that too. You have doubled your income, acquired a debt, and are still caught in what economists call a poverty trap. Most loans are too small to do more. Most environments where loans are made are too poor to support small-business growth. Max Weber’s Naples observation is still too true. You don’t starve, but you don’t gain a little fat either.

But it helps the American saver, or perhaps I should say our surrogate banks, funds, and pensions, and thereby you and me. No one, not even Professor Yunus, makes microcredit loans for free. In fact, despite the benevolent urges of the movement, the microfinance agencies act just like banks. When they have sub-prime customers, and customers in this case without an collateral whatsoever, they do just as sub-prime lenders in the United States do: they charge a premium interest rate for the money. Tim Weiner, an experienced and careful Times reporter who didn’t let his enthusiasm for microcredit blind him to the more uncomfortable facts, reports a 2003 story among Mexican women recipients of microcredit loans. Amidst praise and reassuring quotations from a clay pot maker for whom a loan has allowed her to double her production, Weiner also notes that the non-profit organization making the loan charges an interest rate “five times higher than any United States credit card company could legally charge.”

I imagine every one of us feels a bit ripped off by the interest rates credit card companies charge American users. Multiply those rates by five. Does the concept of usury come to mind? You might say that usury like water seeks its own level. The further down it goes, the worse it gets.

Defenders of microcredit’s high lending rates argue that it beats resort to the local loan shark. Money is money, and if microcredit is cheaper than the local loan shark, so much the better.

But juice is juice. High returns are high returns. Irony of ironies, many microcredit institutions, according to the Economist, have higher rates of profit than Citibank. In 2004, for instance, Citibank made about a 17% profit relative to equity. According to the Economist, seventeen of the largest microcredit institutions made at least as much on their equity as Citibank, the median profit rate among them being 25%. This might explain the enthusiasm of Citibank and others for investing in microcredit institutions. It is one way for international banks to get better profits by serving the poor, heretofore simply bystanders in the game of world finance. They can turn what economists disparagingly call (and blame them for) a “market failure” into a market success, and be better off for it. You and I will be too.

Microcredit activities also do something important to poor communities: they create what Mrs. Thatcher would call “enterprise societies.” No more sodden poor, slacking workers, sullen unions. The poor will be sent on their way, becoming just a buzzing world of fruit stalls, street vendors, and little craft and tourist shops, amidst less edifying hustles of all kinds. A sort of Naples where the gold coin goes round faster and faster, to no greater result perhaps than the growing sensation of envy among those who rub its gleaming surface briefly, but for the first time.

Congratulations to Professor Yunus for a job well done. But the real work of eliminating poverty and increasing economic equality is not yet really begun. In future columns, I will take up discussion of alternatives to microcredit that can eliminate poverty and bring greater economic equality in poor and not-so-poor countries.