The Power of a Dollar
Microcredit is nothing more than a socially validated way for financial elites to exploit the poor.
Illustration by Lennard Kok
Thirty years ago the international development community was ecstatic. It had found the perfect market-affirming solution to poverty in developing countries: microcredit.
The popularizer of this new strategy — which consisted of providing small loans to the poor so they could launch self-employment ventures — was the US-trained Bangladeshi economist Muhammad Yunus, who portrayed microcredit as a panacea that would rapidly create an unlimited number of jobs and eradicate endemic poverty.
Yunus’s project of “bringing capitalism down to the poor” quickly turned him into the go-to-guy for advice on how best to address global poverty. In 1983, flush with funding, especially from US aid agencies and private foundations, Yunus established his own “bank for the poor” — the now-iconic Grameen Bank. Soon, Grameen clones, financed by the international donor community, sprang up across the Global South.
The microcredit movement was born. USAID and the World Bank were particularly supportive of the model, not least because they could now promote self-help and individual entrepreneurship — key components of the neoliberal capitalism both organizations were aggressively pushing at the time — on the basis of them being antidotes to poverty.
Neoclassical economists like Jeffrey Sachs also favored the microcredit model because it seemed to validate their economic development perspective, which was constructed on a foundation of individual entrepreneurship and market interaction. Sachs envisioned microcredit as a way of helping the poor escape their poverty by climbing what he termed the “ladder of development.”
By the mid-2000s, the model was being described as the most effective anti-poverty and “bottom-up” development intervention of all time. With support from across the political spectrum, the UN named 2005 the “year of microcredit.”
Microcredit also became one the few development policies known to, and supported by, ordinary people worldwide — a feat facilitated by the high-profile celebrities who supported the global effort, including Bill and Hillary Clinton, Bill Gates, Bono, Natalie Portman, and Matt Damon.
The movement reached its apotheosis in November 2006 at the Microcredit Summit in Halifax, Canada, an event that celebrated the progress to date while also extracting pledges from participants to ramp up the microcredit supply. With delegates bathing in the warm afterglow of the announcement some months earlier that Muhammad Yunus and the Grameen Bank would share the 2006 Nobel Peace Prize, there appeared to be nothing the model could not achieve.
Presenters argued that microcredit could positively impact health care, the environment, terrorism, and a whole host of other problems. Bernd Balkenhol, then head of the International Labour Organization’s Social Finance Unit, best encapsulated the movement zeitgeist when he described microcredit as “the strategy for poverty reduction par excellence.”
With ambitious expansion plans laid out, a future in which virtually every poor individual on the planet (especially women) could easily access microcredit appeared to be near. Also seemingly on the cusp of becoming reality were Yunus’s oft-repeated claims that microcredit would “eradicate poverty in a generation” and that our children would soon have to visit a “poverty museum” to see what all the fuss was about.
And then it all began to go horribly wrong.
The catalyst for the dramatic turn against microfinance was the Initial Public Offering (IPO) of Mexico’s largest microcredit bank, Banco Compartamos, in 2007. Here ordinary people learned not of microcredit’s impressive successes in reducing poverty in Mexico — there was and still is absolutely no evidence of this — but of the spectacular level of profiteering by senior managers and outside investors.
Most working in the microcredit sector were stunned by the sheer avarice of those involved. But “the Compartamos scandal” soon proved to be the tip of the iceberg. When numerous other instances of personal enrichment and unscrupulous behavior surfaced, it became clear that the microcredit model had essentially been taken over by greedy entrepreneurs, aggressive private banks, and hard-nosed investors.
At the same time, the veracity of the reports justifying the microcredit concept was increasingly being called into question. The evidence was so weak, in fact, that one major government-financed study in the United Kingdom concluded that the entire microcredit movement had been “constructed upon foundations of sand.” After a number of spectacularly destructive “boom-to-bust” episodes in all of the countries and regions where microcredit had reached critical mass, the previously rock-solid belief that microcredit helped the poor rapidly crumbled.
In little more than thirty years, the microcredit concept has gone from being equated with Zorro, the mythical Mexican hero and friend of the poor and exploited, to being widely referred to as a zombie policy, a dead and rotten idea that nevertheless keeps rising from the grave. How did it come to this?
Heightening Immiseration
The modern microcredit movement’s central problem is that it rests on a fundamental misunderstanding of economics. Yunus believed that the poor, and especially women, could establish an informal microenterprise and then sell basic goods and services to other poor people in the community.
This assumption was applied even in the poorest communities, where the poor (by definition) struggle to afford the simple items and services conducive to their basic survival. But Yunus thought that as long as the destitute could produce something, they could sell it. As he later famously put it, a “Grameen-type credit program opens up the door for limitless self-employment, and it can effectively do it in a pocket of poverty amidst prosperity, or in a massive poverty situation.”
Unfortunately, Yunus had embraced a long-disproven fallacy known as Say’s law — the idea that supply creates its own demand. As the late economist Alice Amsden explained, the core problem in developing countries is not the supply of basic items, but the sheer lack of local demand (or purchasing power) required to pay for them. Even in the poorest communities, there are generally enough retail stores, street food outlets, basket makers for people to access — if they have the financial means to do so.
A local “demand constraint” underlies two of the main shortcomings associated with microcredit: displacement and exit. Displacement occurs when new jobs and incomes registered in one microcredit-supported enterprise are cancelled out by the decline in jobs and incomes in incumbent competitor microenterprises. Exit is the process whereby both new and existing microenterprises are forced to close, due to the additional supply of informal microenterprises operating in the same sector.
As David Storey, an expert on small business policy, points out, “the single most important fact to be borne in mind when implementing measures for smaller firms is the high death rate of such businesses.” The reality behind the microcredit hype is that the vast majority of those who took out a microloan to invest in some income-generating project ended up failing or else displacing other struggling informal microenterprises operating in the same sector.
Failure leads to personal over-indebtedness, the diversion of other income flows (remittances, pensions) into repaying the loan, the loss of family assets pledged as collateral (land, housing, vehicles), and humiliation, despair, and, in far too many cases, a descent into inescapable poverty.
Taken together, displacement and exit explain why the microcredit model brings little to no net increase in employment. In microcredit-saturated Bosnia, for example, all the early claims of massive job creation were transparently false because evaluators refused to take these issues into account.
Indeed, it is difficult to find any impact evaluations that factor in displacement and exit. In all too many cases, the desire to please the client — typically a microcredit partisan — has won out over any ethical or professional imperative to report reality.
Nonetheless, these obvious shortcomings also help explain why, as even longstanding supporters now acknowledge, there is no empirical evidence showing microcredit cuts poverty. As a rule, it simply boosts the rate of informal microenterprise entry, which is then followed by an equally high rate of displacement and exit, creating nothing more than an unproductive and wasteful local dynamic known as “churn” or “turbulence.”
As Mike Davis writes, artificially stimulating hyper-competition in developing countries’ local markets is not the way out of poverty and human suffering, but an increasingly ugly manifestation of it.
Another indication of the failure of microcredit is that in many developing countries, the poor no longer avail themselves of microloans for business ventures, knowing they will likely either struggle to make money, or else quickly fail. Instead, a growing number use microcredit to pay for much-needed consumption goods.
Borrowers hope to eventually repay the microloan, perhaps through some unexpected financial windfall or a rare spurt of business success. But in practice the poor increasingly take out larger and larger microloans — and very often more than one — simply to cover repayments due on previous microloans, a Ponzi-like dynamic referred to as “loan bicycling.” This in turn has helped push up individual over-indebtedness, which in a growing number of developing countries has reached staggering levels.
Too Many Entrepreneurs
An even more fundamental problem with microcredit stems from its role in securing a long-term “bottom-up” development trajectory. Aware that there’s scant proof that microcredit has a positive short-term effect, many advocates have started insisting we look to the long term — there, they insist, is where microcredit is most effective, supporting the entry and gradual proliferation of micro-entrepreneurs in places where they are desperately needed.
Africa is the most frequently cited example of a region held back by a shortage of entrepreneurs. The international development community, aided by a number of high-profile African economists like Dambisa Moyo, have been at pains to argue that microcredit is desperately needed to create an African entrepreneurial class that can serve as the vanguard of sustainable development.
This argument is almost entirely bogus. As development economist Ha-Joon Chang points out, Africa already has more individual entrepreneurs than perhaps any other place on the planet — and many more are being constantly produced thanks to rafts of new microcredit programs and because Africa’s commercial banks are shifting into microcredit operations.
This glut of micro-entrepreneurs actually hinders long-term development. By generating superfluous “buy cheap, sell dear” trading operations, microcredit effectively precludes the emergence of a more productive, industry-based, and growth-oriented local economic structure. And the intense competition brought on by waves of new informal microenterprises militates against organic growth by better-placed formal enterprises.
The case of South Africa is illustrative. The first post-apartheid African National Congress (ANC) government encouraged the expansion of microcredit and informal microenterprise sectors as an attempt to tackle poverty and unemployment among black South Africans. But the strategy proved disastrous for South Africa’s poor.
A microcredit-driven increase in informal microenterprises in the black townships and rural areas, combined with almost no additional effective demand (due in part to a World Bank austerity program and the ANC’s neoliberal economic policies), helped depress average incomes in the informal economy — around 11 percent annually in real terms from 1997–2003. The self-employment jobs created by the expansion of the informal sector were more than offset by the fall in average informal sector incomes. As a result, poverty spiked.
The microcredit movement thus did nothing more than help plunge large numbers of black South Africans into deeper over-indebtedness, poverty, and insecurity. Meanwhile, a tiny white South African elite has become extremely rich off of supplying microcredit. Not surprisingly, many in South Africa now consider microcredit as analogous to the US’s subprime mortgage crisis, but with even more disturbing overtones of race-based exploitation.
Consider too the situation in Latin America, where since the early 1990s an increasing number of dedicated microcredit institutions and “downscaling” commercial banks have massively expanded the supply of microcredit. The bottom-up, microenterprise-driven miracle that neoliberals like Hernando de Soto long promised is nowhere to be found.
Instead there is growing evidence that channeling Latin America’s scarce financial resources (savings and remittances) into ultra-low-productivity informal microenterprises and self-employment ventures, as well as into consumer loans, has contributed to the progressive destruction of the continent’s economic base.
This negative assessment was even shared by the mainstream Inter-American Development Bank (IDB), which reported in 2010 that the market-driven proliferation of informal microenterprises and self-employment ventures was the principal cause of that continent’s twenty-year (1980–2000) descent into more acute poverty, inequality, and economic weakness. The IDB’s conclusion was unequivocal: “the overwhelming presence of small companies and self-employed workers is a sign of failure, not of success.”
The microcredit-induced expansion of the informal microenterprise sector in developing countries is not one of the solutions to endemic poverty, inequality, low productivity, and general under-development, but one of the chief causes.
Neoliberalizing Microcredit
The final problem with microcredit grew out of the model’s effective neoliberalization in the 1990s.
While Muhammad Yunus and Bangladesh are most commonly associated with microcredit, the model actually first emerged in 1960s Latin America as part of the US government’s attempts to quell anticapitalist social movements and resistance to American imperialism.
The hope was that if enough of the poor could be pacified through self-help and individual entrepreneurship, they would have no need for structural solutions to poverty like an active state, trade unions, welfare systems, or worst of all, socialism.
With the global neoliberal political project in ascendance, however, the microcredit paradigm came under intense pressure to conform to even-narrower operational confines.
Initially structured as NGOs and funded by external sources (by the international donor community, private foundations, or governments), such microcredit institutions were anathema to the new generation of neoliberal policymakers. So under the direction of USAID and the World Bank, the microcredit model was extensively neoliberalized — turned into a for-profit, private sector–driven business model operating according to supposedly ultra-efficient, Wall Street-style incentive structures overseen by “light touch” regulatory bodies.
Egged on by high-profile neoliberals like Maria Otero and Elizabeth Rhyne (both then at ACCION), and Marguerite Robinson (based at Harvard), the claim began to circulate that a “new world” of massive poverty reduction and “bottom-up” development had been midwifed.
However, the neoliberalization of microcredit only succeeded in adding a disastrous new twist to an already-unfolding catastrophe for the poor. Commercialization and deregulation directly, and quite predictably, caused spectacular levels of greed, profiteering, and corruption in the microcredit sector.
Many Western banks and funds opportunistically entered the microcredit business to enrich senior managers (through high salaries and bonuses) and shareholders (high dividends and capital appreciation). In Mexico, for example, even leading microcredit advocates now accept that the major banks and corporations that jumped into the industry all achieved remarkably high returns by pushing poor Mexican women into severe debt.
Then there are the high-profile individual entrepreneurs — often termed “social entrepreneurs” — who have become “microcredit millionaires.” Perhaps the most notorious example is Vikram Akula — former McKinsey consultant, self-described “poverty activist,” and, in 2006, one of Time magazine’s one hundred most influential people.
Akula set up his own microcredit institution and, using a wide variety of manipulative and unethical practices, became one of India’s richest individuals. He was also the leading figure of the “big six” microcredit institutions in India’s Andhra Pradesh state, whose collective greed and reckless growth strategies helped bring the entire microcredit sector to its knees in 2010.
Akula is only the most extreme example, though. Even the leaders of the main microcredit advocacy bodies have joined the feeding frenzy. Rupert Scofield, CEO of the US-based FINCA microcredit advocacy and investor body, rewarded himself in 2013 with a $711,000 paycheck. This at a non-profit body that, while tempering its usurious behavior after increased scrutiny, still charges poor clients interest rates that regularly approach 100 percent.
As Philip Mader documents, the most pronounced dynamic at work in the microcredit industry over the past two decades has been the extraction of a huge amount of money from the poor, in the form of interest payments first passed back to microcredit institutions and then onto investors in developed countries. The global microcredit movement has provided nothing more than a new and, importantly, socially validated mechanism through which financial elites can extract resources from the poor.
To make matters worse, market-driven microcredit is associated with depressingly regular crises and “microcredit meltdowns,” as well as the social and economic chaos that comes from heightened over-indebtedness.
Beginning with a “microcredit meltdown” in Bolivia in 1999 — an event dismissed at the time as a “one-off”— the rot really began in 2009 when microcredit crises broke out in Bosnia, Nicaragua, Pakistan, and Morocco. Bangladesh’s much-vaunted, but massively saturated, microcredit sector only survived its own meltdown in 2009–2010 after behind-the-scenes pressure was exerted on leading individuals and institutions to abandon their breakneck growth strategies and share the market.
Today, many more countries are on the verge of a “microcredit meltdown,” including Mexico, Peru, Cambodia, and, just five years after its unprecedentedly large convulsion, India.
The Sobering Reality
Despite its manifest unworkability, if not its full-blooded destructiveness to long-term development aims and sustainable poverty reduction, the microcredit model remains an icon within the international development community.
Indeed, faced with the collapse of the model under the weight of its own contradictions and failures, the World Bank is undeterred. It remains so enamored of microcredit that it recently began a deeply cynical rescue mission by reclassifying it under an almost entirely fake new agenda — “financial inclusion.”
Under this plan, the extension of microcredit is no longer enough. To be fully included in the financial system — and to supposedly create the conditions for poverty eradication — the global poor urgently need access to micro-savings, micro-insurance, and micro-leasing, as well.
The breathtaking weakness, complete lack of evidence, and obvious cynicism of this new agenda has not stopped it from becoming the new “best practice” in local finance, and infused it with the same passion and commitment that animated the microcredit movement. Predictably, it has already spawned its own set of Yunus-like “faith healers,” like Jeffrey Ashe — the one-time microcredit pioneer who admitted the error of his ways but has now been reborn to lead what he calls “the micro-savings revolution.”
Why is such nonsense and deception tolerated? What is it about microcredit that allows it, despite decades of failure, to be simply rebranded so it can continue to undermine sustainable development and harm the global poor?
The Ideology of Microcredit
The most immediate reason is that microcredit is extremely profitable.
As the case of Banco Compartamos first highlighted — and later confirmed, when in 2013 it paid out €154 million in dividends to its investors — it is possible for external investors to make enormous returns in the microcredit sector. Private commercial banks began to both lend to, and invest in, many of the largest microcredit institutions, and they have reaped spectacular rewards by charging extremely high interest rates.
In Cambodia, for example, the largest and most profitable bank, ACLEDA, which is also a microcredit bank, had investment houses falling over themselves in 2009 when it offered a share of its equity (the business conglomerate Jardine-Matheson Group won out, taking a 12.25 percent stake).
Microfinance’s high “risk-adjusted profitability” also explains why Wall Street’s hedge funds have been moving into the sector since the early 2000s, particularly in countries like India.
With so much relatively easy money on offer to savvy investors, and with the CEOs of the leading microfinance institutions now willing and able to grab a significant share of the profit themselves in the form of huge salaries and bonuses, there’s an obvious incentive to pressure the international development community to keep backing the programs.
This explains the vast resources expended by commercial banks, venture capitalists, hedge funds, and other would-be investors on promoting the microfinance industry. Even high-profile web discussion blogs are now sponsored by the financial sector (for example, the Guardian runs a financial inclusion blog sponsored by Visa).
But profitability is just one half of the explanation for the microcredit model’s widespread support among policymakers, politicians, and ordinary people. The issue of ideology is also central.
Microcredit is supremely attractive to the neoliberal development community and neoliberal politicians. Within these circles criticism of microcredit and the central role that individual entrepreneurship supposedly plays in the development process is simply not tolerated. Instead it is aggressively rebuffed, because such skepticism is, in essence, skepticism of capitalism itself.
This is the reason for the huge PR effort currently being mounted by the World Bank and others — and backed up by a range of like-minded politicians, foundations, and high-profile NGOs in the US and elsewhere — in support of “financial inclusion.” As Mader and Sabrow demonstrate, one of the financial inclusion project’s central goals is to physically rescue high-profile microcredit institutions from (deserved) obsolescence and closure.
The financial inclusion agenda is primarily designed to create the appearance that individual entrepreneurship works as the neoclassical textbooks tell us it does, stifling discussions of left alternatives in developing countries. If this sounds cynical, it is the only sensible interpretation considering the gross misrepresentation of data, the extensive use of cherry-picked case studies, and the muffling of all critical viewpoints that currently characterizes financial inclusion boosterism.
Of course, many well-meaning people and institutions recognize that poverty is not being wiped out, and they genuinely want to do something about it. Donating to a microcredit institution is seen as a simple, effective way to address the persisting scourge.
But by the same token, microcredit validates the belief in the supposed power of US-style individual entrepreneurship and free markets to eradicate poverty. Poor people just need to be entrepreneurs and they will escape immiseration — they don’t need to organize, demonstrate, strike, form a leftist political party, or agitate for radical, structural remedies to their impoverishment.
By mobilizing funds to support micro-lending programs in developing countries, microcredit acts as the perfect medium through which such pro-capitalist ideological foundations and motivations can be formed, nurtured, reinforced, and very practically expressed. Preserving the microcredit model therefore benefits the international development community — it embeds capitalist ideology in successive generations in both developed and developing countries, and it advances the long-running goal of depoliticizing international development.
One example of this depoliticization at work is the hugely popular Kiva, a nonprofit organization founded in 2005 to mobilize loan funding from the rich world — especially from US college students — in order to help poor entrepreneurs in developing countries get started.
Despite using willful deception to attract initial funding and attention — the two founders falsely claimed that Kiva members gave a small loan directly to an individual they chose on the Kiva website, rather than simply to a microcredit institution — the nonprofit has nevertheless flourished by promising donors they can “empower people around the world with a $25 loan.”
However, Kiva’s emphasis on providing small microloans only semi-directly (that is, through microcredit institutions) to micro-entrepreneurs in developing countries has almost nothing to do with actually fighting poverty. The “Kiva experience” is much more about Kiva supporters seeking a form of personal gratification by donating a small sum, as well as validation that their ideology (capitalism) actually works.
As marketing expert Domen Bajde explains, Kiva’s success is based on “entrepreneurial charity” — the comforting notion that savvy entrepreneurs in countries like the US can meaningfully curtail grinding poverty in developing countries by directly supporting micro-entrepreneurs. No need for solidarity movements and active resistance to exploitation and unfair conditions imposed on developing countries — just send a donation to Kiva and the poor can take care of themselves!
A Failed Model’s Future
With microcredit having manifestly failed in terms of promoting sustainable development and reducing poverty, it is difficult to predict what comes next. Many onetime supporters like Hugh Sinclair, and even some globally recognized advocates and institutions like Catholic Relief Services, are abandoning it as unsuccessful. Effectively supporting this decision are a growing number of high-profile US-based academics and previously high-profile advocates, who now concede that the data show microcredit is a flawed antidote to poverty.
One of the most damaging effects of the microcredit movement has been its displacement of more developmentally effective, community-driven local financial institutions — like credit unions, financial cooperatives, and state development banks — from the policy agenda. But in the wake of the 2008 financial crisis, and growing awareness of the dangers of microcredit, alternative institutions are making a comeback, particularly in the Global South.
Nevertheless, it seems likely that the microcredit model will endure in some form before it is replaced by the similar, but much broader, financial inclusion agenda. After all, this is what the World Bank wants — and it has support from numerous corners, including powerful global financial institutions and funds.
When the financial inclusion agenda does eclipse microcredit, it will be no cause for celebration. The program suffers from the same pitfall as microfinance: it protects and enriches a narrow global elite, while offloading risk onto the poor themselves.
Democratizing finance in a radical way will require the Left to move beyond the micro-scale, and develop collective, cooperative, and state institutions to promote sustainable development and finally end poverty.