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There is surprising consensus between the left and right about microfinance: both camps believe that it is one sure way of removing poverty.
The announcement last week that Muhammad Yunus, the founder of Bangladesh's pioneering microcredit institution, the Grameen Bank, had won the Nobel peace prize provides the ultimate imprimatur on the idea that microfinance works for the poor.
Progressives like it because it keeps big business out and establishes a cooperative, self-help model where NGOs play a major part. Free-marketers love microfinance because it keeps out the state and its handouts, and can even teach borrowers responsibility.
But is microfinance necessarily a sound proposition for poverty alleviation? Yes, microfinance is good, but that has more to do with social politics than economics.
Microfinance is often targeted at women, empowering them in societies with deeply entrenched views of gender roles. But don't expect economic indicators to improve, incomes to rise or poverty levels to fall substantially.
Dr Yunus began 30 years ago by distributing about $27 (£15) worth of loans among 40 extremely poor Bangladeshis. Since Grameen formally opened in 1983, it has loaned $5.7bn in microfinance and now has 6.6 million borrowers in Bangladesh.
Dr Yunus says the loans are entirely financed by borrowers' deposits, so the poor are truly funding the poor.
The phenomenon is now global: development experts and Wall Street banks want a piece of the action. As of December 2004, 3,100 microcredit institutions reported reaching 92m borrowers, most among the world's poorest.
One of the most thoughtful critiques of microfinance comes from Vijay Mahajan, the chief executive of Basix, an Indian rural finance institution. Mahajan has raised questions about microfinance's sustainability from a purely economic perspective.
He says that its proponents make five "fatal" assumptions about microcredit, which leads them to overlook its limitations.
The first assumption is that the poorest wish to be self-employed, when the majority actually want steady wage-employment.
The second is that credit is the main financial service the poor need. Mahajan argues instead for the importance of savings and insurance, to cushion the very poor through an unexpected crisis.
The third assumption is that credit access translates immediately into successful micro-enterprises. Microfinance is necessary, but other factors - identifying opportunities, training, establishing market linkages for inputs and outputs - are at least as important for success.
The fourth assumption is that those just above the poverty line do not need microcredit, and giving it to them amounts to mistargeting. But, in fact, microcredit benefits the slightly better-off more.
David Hulme and Paul Mosley have shown in their book Finance Against Poverty that the increase in income of microcredit borrowers is directly proportional to their starting income.
The "vast majority" of those starting below the poverty line "end up with less incremental income after getting a microloan", says Mahajan. He concludes that
microcredit "seems to do more harm than good to the poorest".
Finally, it is assumed that microcredit institutions can all become financially self-sustaining. Mahajan contends they can't.
Many have expressed scepticism of the model, starting in 2001 in the Wall Street Journal.
Two of its correspondents, Michael Philips and the late Daniel Pearl, suggested that Grameen was often rolling over unpaid loans and its non-performing loans were higher than investors were being told.
Dr Yunus responded that its performance cannot be judged by strict financial parameters, and there is some logic to that argument. But critics still argue that microfinance primarily rests on subsidies.
There is nothing wrong with well-targeted subsidies: just make them explicit, then there can be a debate over what the state should subsidise. The mistaken notion, Mahajan contends, is that microcredit only needs temporary subsidies.
There are other social issues. The Grameen model depends on peer pressure to guarantee repayments, making the entire borrowing group accountable for each member's repayments.
This has led to acrimony and, in some cases, violence - endangering, in particular, the very women that microcredit is meant to empower.
Another problem is that debt gets recycled, as people borrow at subsidised rates to repay older loans. Money circulates from "good" lenders to "bad" lenders. The income effect is negligible.
The Bangladesh Institute of Development Studies points to a 0.8% decline in rural poverty between 1991/92 and 1995/6, which it calls "a modest achievement by any standard". Half of Bangladesh's population remains below the poverty line.
When Bangladesh became independent in 1971, the then US secretary of state, Henry Kissinger, is said to have called it a "basket case". Even though Bangladesh has made impressive strides on certain human development indicators, its economic indicators remain poor.
Progress has come in sectors such as garments, fisheries and exports, where the loans required to build factories are far larger than microfinance can provide.
The very poor need higher wages and guaranteed employment, not further indebtedness. They have no economic incentive to take loans in the longer term, because repayments would far exceed the principal. The primary impact of a microloan is to give the poor some money at hand to pay for their immediate needs.
Finally, the Grameen model is not necessarily applicable worldwide. While it has been hugely successful in Bangladesh's trade-dominated economy, results in more agrarian economies, such as India or many parts of Africa, are mixed at best.
That's why, to appreciate Grameen's real worth, we need to look at its role in empowering women. That is its real success, and for achieving this in a conservative, largely rural society such as Bangladesh, where Islamic fundamentalism is on the rise, Dr Yunus deserves his Nobel prize.
· Salil Tripathi is a writer based in London who was a regional economics correspondent at the Far Eastern Economic Review in Singapore.Source: www.theguardian.com
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