PERSPECTIVES

Too Good to Be True

The Remarkable Resilience of Microfinance
THOMAS W . D I C H T E R ¡S an expert in international development and mi-
crofinance. He served as a senior consultant to the World Bank*s "Sustainable
Banking With the Poor*' project and is currently at the Cato Institute. He is
the co-author of What's Wrong with Microfinance? (Practical Action, 2007).
ien the concept of underdevelopment a minimum over half the funds committed to microfinance
took shape in the middle of the last today are subsidized. Wliy should this be so? The only good
century, the search for the holy grail reason to subsidize microfinance is if it has a demonstrable
of poverty reduction began in earnest. impact on poverty reduction or some other measurable social
And while many answers to the daunting benefit that is otherwise unachievable. But it does not.
challenge have been offered, none of the ideas put forth has Microfinance's anti-poverty promise and its growing
had greater appeal or more endurance than microfinance. popularity are less a mystery if one looks at microfinance
Yet no other longstanding idea about poverty reduction rests "memetically"—^that is, as an idea which has spread conta-
on as little empirical evidence of success. giously, propelled in part because so many of its proponents
This is not to say that microfinance cannot work as want its promise of poverty reduction to be true, and indeed,
a business concept. There are a number of microfinance need it to be true. The appeal of microfinance is remark-
institutions (MFIs) which make money (at least two, one in ably broad, flawlessly magical, and has the added benefit of
Mexico and one in India have even taken the initial public brevity—microfinance's anti-poverty promise can be stated
filing route) and a fair amount of what is now called mi- in a couple of simple sentences: lend money to poor people
crofinance is done under the aegis of commercial or other who will invest in tiny businesses, and with their profits pay
types of banking institutions, such as credit unions, which back the money and gradually rise out of poverty. And as
have been around for a long time. These kinds of MFTs are more and more of such services are available, these "micro-
not subsidized by development-oriented public or private enterprises" will contribute to (and even drive) economic
grants or soft loans. As such, they can go about what they do growth. The idea reaches the heart and the head (see below),
whether or not their claims to a greater good rest on a solid the ideological left and the right, and contains an almost
foundation or are merely good public relations. universally irresistible narrative: the poor can be agents of
But even given today's loose array of entities that call their own destiny if only they have a chance to access formal
themselves MFIs—ads in the Paris Metro for consumer loans financial services, which, especially and for almost all of the
to the middle class refer to their loans as "microfinance"—at history of microfinance, takes tlie form of microcredit.

HARVARD I N T E R N A T I O N A L R E V I E W • Spring 2010

 PERSPECTIVES
I have argued elsewhere that perhaps one of the reasons do the same thing. Reporting on the same M I T study last
explaining the serious lack of rigorous research on micro- year, it called microfinance a "pardal marvel" and concluded
Imance's impact on poverty is that the idea was so strongly that while we have seen no poverty impacts yet, we might
cherished that no one wanted to risk hearing that it might some day.
not work. Eor years the field took refuge in saying that It seems clear that the magical promise of the microfi-
what counts is high repayment rates (a proxy for success), nance "marvel" retains enough power to draw even its most
or that the dii^culties (and cost) of rigorous research were radonal proponents into rituals that look suspiciously like
too daunting and in the end not worth it. denialism. Let us consider a few others that contribute to
But in 2009, for essentially the Brst dme, research the endurance of the idea of microfinance as a powerful tool
based on rigorous randomized controlled trials showed that for poverty reducdon.
inicrofinance has no sustained effect on poverty reduction,
much less economic growth. The Massachusetts Institute Manipulating Symbols anil Language
of Technology (MIT) Poverty Action Lab study in India Microfinance broke through to public consciousness
as well as a study using randomized controlled trials in the in the mid to late 1990s because of a growing corpus of
Philippines by academics Dean Karlan and Jonathan Zin- anecdotes about its anti-poverty success that made gt>od
inan both found that microcredit did not reduce poverty. In journalisdc "copy." The public does not much like complex
addition, a recent study of four high microfinance growth analyses or dry stadsdcs but it does like heart-rending stories
countries (Bosnia-Herzegovina, Nicaragua, Morocco, and of people, especially women, whose "businesses" and hence
Pakistan) showed rising default and delinquency problems whose lives appeared to be transformed by dny loans. These
.IS well as a pattern of the poor borrowing from multiple stories condnue to be the main vehicle for fundraising in
sources. Moreover, many microfinance practidoners who almost all microfinance organizations. Examples of these
work directly with clients on-the-ground have long noticed organizadons range from venerable early pracddoners like
that the poorer the borrower, the more likely the borrower's Acción and Opportiuiity Internadonal to newcomers like
economic activity is for the purpose of survival with little Kiva.org, which has creatively adapted the emodonal con-
likelihood that activity will become a genuine and thriving necdvity of child sponsorship to the presumed world of the
business. micro-entrepreneur.
One might have thought that years of such observadons The stories use a common set of emodonal and intel-
combined now with widely circulated rigorous quandtadve lectual symbols that cover both ends of the "temperature"
studies would shake the field to its core. If microfinance spectrum—women's empowerment, investment in the chil-
does not reduce povertv', if indeed promoting credit is also dren's nutridon and education, on the "warm" end, appealing
promodng debt, if poor borrowers in developing nations end to those whose interest in poverty is led by their heart. On
up in the equivalent of Anierican-style credit card overload, the "cool" end are business, enterprise, work and change,
iind if the majority of poor people in the global South—like nppealinti to those who are more attracted to "hard-headed"
most people in the North—are not
entrepreneurs, then what is the
point of promoting microfinance
as anything other than just another
specialized business which ought to
be left to go its merry way, without
subsidy? Instead, the microfinance
industry rocked unsteadily on its feet
tor a bit, but then began to rally in
defense. A recent piece by the Con-
sultadve Group to Assist the Poor
(CGAP), after discussing the MIT
research, unaccountably concludes
that it is too early to tell whether
niicroHnance is successful in reduc-
ing poverty.
One can understand the temp-
tation on the part of microfinance
insiders to cling to belief and take
refuge in rituals like "too-soon-to-
icU." But even The Ëcono?nisî^ an icon
of thoughtful reporting on world
A vendor makes footwear at the open-air Ngara ; wC near Nairobi, Kenya. Tens
issues, and with no apparent stake of millions of Kenyan residents have obtained loans from the many microfinance
in inicrofinance, seems to want to organizations based in Africa.

Photos Courtesy Reuters Spring20]0" H A R V A R D I N T E R N A T I O N A L REVIEW

 PERSPECTIVES
solutions to poverty that evoke images of the private sector
and die power of markets.
An examination of the websites of these and many other
microfinance organizations shows a remarkable sameness.
They talk about giving people the financial tools they need
to lift themselves up or to work their way out of poverty.
They tell inspiring stories about women in places such as
Lagos, Nigeria or southern Sudan who sell vegetable oil,
sugar, onions, or who cook food for sale, and who with
microloans have been able to buy more stock, "build their
business," and thus begin to help their children eat better.
They talk about changing lives. They talk about empower-
ment. And they talk about the "power" of microfinance as a
poverty reduction tool.
Leaving Things Out
Of course, we understand that these appealing symbols
and the accompanying loaded language are designed to get
money. And so the message must be simple, just as it is in the
world of advertising, and likewise much has to be left out.
Part of die message is that these people are just like you and
"Microfinance is now an industry, and like any other, it wants to grow.
It bases its prospects not only on the promise of poverty reduction but
also on the premise that the demand for it is vast and unmet."
me—just give them a chance, and they will lift themselves
up. But context with all its complexities is left out. The so-
liciting organization does not want to get into these details,
which might confuse the donor, and the average donor does
not really want to hear, for example, that south Sudan is
not like Pittsburgh and so adding rice to a sidewalk seller's
sugar and onions "business" is not very likely to move her
out of poverty.
More important is what is left out in the belief structure
of the proponents of microfinance themselves, beginning
with the history of the developed countries and what role
mass access to formal financial services, especially credit, did
or did not play in their development. History shows clearly
that formal credit access was a product of economic growth
and not a driver of it; most businesses in the past began (and
still begin today) with informal financing rather than formal,
and the demand tor access to formal financial services was
based on the powerful combination of thrift (savings) and
the use of those savings as the basis for consumption and not
for enterprise investment.
Microfinance's most prominent ancestor, Mohamed Yu-
nus, left out this inconvenient history when he linked formal
credit access of the poor to development. In his now-famous
declaration of credit as a human right in the 1980s, Yunus
saw credit as an empowemient "weapon" and the poor as
the engine of development. He and many others have also
consistently left out the obvious point that the darker side of
HARVARD INTERNATIONAL REVIEW« Spring 2010
credit is debt—something the poor themselves recognize.
In micro finance's 35 years it has always been convenient
to see what the pioneers and practitioners do as essential,
and to leave out those realities that might suggest that what
they do is not only not that important, but not as much in
demand as they think, nor perhaps even necessary. Until
relatively recently, savings, tor example, was at best a weak
sister to credit, even though savings is a better driver of de-
velopment than credit, does not need subsidies, and is also
preferred by the poor.
Microfinance is now an industry, and like any other, it
wants to grow. It bases its prospects not only on the promise
of poverty reduction but also on the premise that the demand
for it is vast and unmet. For decades it has been pointed out
by microfinance's champions how many of the world's poor
do not have access to formal financial services. A recent
estimate (cited by E. Rhyne in the Marcli/April 2010 issue
o(Microfinancc hisights) is that over half die world's adults do
not use such services, and that these 2 billion people are by
definition an "unserved" market and even an "excluded" mar-
ket. But just because many people are not invited to a party
does not mean they would all come if asked. If the roughly
1,400 self-declared microfinance institutions reporting to
the Microfinance Information Exchange (MIX) therefore
serve less than 5 percent of the potential market, could it
be possible that much of this potential market is either not
interested, wary, or not ready to participate?
This leads us to the next significant issue left out—in-
formal finance. Another recent work getting considerable
traction these days is a study based on daily journals of how
die poor acquire and use money. Called "Portfolios of the
Poor," it shows what has been known by some on-the-ground
practitioners for years: the poor are quite resourceful in
coping, especially in their use of informal finance which is
multifaceted and often adapted to their needs.
Nearly 16 years ago in his paper, "Balancing Perspec-
ties on Informal Finance," Otto Hospes not only detailed
the variety and complexity of these informal mechanisms,
but lamented the lack of interest in them by the growing
microfinance industry. He pointed out that informal fi-
nance is much closer to the real world of the poor than are
donor-driven credit schemes, and therefore, that he did not
see why people in the world of microfinance did not seem
to think it worthwhile to achieve a better understanding of
infomial finance.
While others, decades ago, were also looking at infonna 1
finance (e.g.. Dale Adams, J.D. von Pischke, Carl Liedholm,
Parker Shipton), it has apparendy not been convenient for
 PERSPECTIVES
ihe inicrofinance field to continue deepening this area of women, empowers people and thus, over time, translates
work. The field has continued to avoid any suggestion that into significant positive changes in the social structure. In-
lack of capital or lack oí access to formal financial services terestingly, recent research suggests that even these effects
may not be the major obstacle standing between the poor are less impressive than hoped.
^ind wealth creation. An inductive approach to research, only Finally, perhaps again to ensure that microfinance
now undertaken by the "Portfolios ot the Poor" work, ought continues to be seen as relevant, the field has expanded to
to have been undertaken from the outset of niicrofinance 35 include new ventures such as microinsurance, the easing of
years ago—that is, instead of beginning with a presumed the transaction costs in remittance transfers, housing finance,
need for fonnal credit, and a further presumption about and, at long last, savings promotion. This is all to the good.
how that credit would be used, one begins by asking how But it has happened as part of a quiet drift away from targets
the poor in fact get and use money.
If microfinance appears now more willing to accept the
reality of informal finance, it is far from willing to entertain
two possible collateral conclusions: 1) that a great many
people may not want or need access to any or all formal
linancial services; and 2) that the backbone of microfinance—
microcredit—may be a supply-driven phenomenon created
as a product of the microfinance industry's need to be seen
as central to poverty reduction.
Finally, microfinance has of course left out the possibility
ihat it might be harmful, not just to people, but to the goals
iii development. Because the typical subsidized microfinance
inter\'ention is aimed at helping tlie poor directly, it is usually
caught in a focus on low-capital, low-skills, low-knowledge,
and low-tech activities. Milford Bateman's work suggests that
this recipe results in an "infantilization" of the economy,
and thus much inicrofinance work prevents growth and is
"anti-developmental."

Moving the Goal Posts

As some in the microfinance field began to notice that
a) the poor, especially the poorest, were not born entrepre-
neurs; b) buying and selling a bag of rice in the informal
sector not only does not lead to economic growth, but be-
cause the barriers to entry are low, more rice sellers come
along with tiie result that each seller gets a smaller piece of
the same economic pie; and c) the expectation that all MFIs
could be profitable and self-sustainable was not happening,
microHnance began to move the goal posts to refit the field
with new impacts, more modest to be sure, but ones touted
with equal enthusiasm.
These new impacts fall under two categories. The first,
emphasized since the mid-1990s, might be called "cushion-
ing effects," such as "consumption smoothing"—the use of
loans to iron out the bumps that occur when a poor family
needs cash for an emergency, or their use for a social event
perceived as obligatory (weddings, funerals, etc.). We have
long known that a great deal ot daily life of the poor is about
coping with risk and mireliability. Microfinance now often
promotes itself as a key to this kind of coping. {Consumption
smoothing has been long understood by money-lenders,
who, it should be remembered, the microfinance field once
hoped to eliminate. But they are still around, and the reason
is that they provide a service at high rates but low transac-
tion costs for which the poor are willing to pay.) The second
categor}', which might be called "empowertnent effects,"
is the idea that access to financial services, especially by
A woman counts the money that she has collected from a
microfinance organization located rn Manikganj, Bangladesh.
that were once sacred (the poorest) and toward those who
are considerably less poor and whose services and needs are
far less "micro."
The instinct for survival and tlie search for meaning-
fulness are behind many belief systems. Microfinance is
no different. Through the kinds of mechanisms discussed
above, especially with its powerful use of symbols, the mi-
crofinance industry appears to have achieved both. This
may help explain why microfinance has been able to cross a
divide hitherto never bridged in the history of development
assistance—the line between the capitalist for-profit com-
pany and the non-profit world of public and private agencies
whose purpose is to help others. Thus we have seen since
the end of the 1990s a growing number of microfinance
"investors." Today, major banks and companies have cre-
ated microfinance units, and a host of funds have come up
to move microfinance into the realm of the private sector.
The ultimate magic is now at hand—one can make money
while doing good, or so it is hoped. (It

Photo Courtesy Reuters Spring 2010 • H A U V A R D I N T E R N A T I O N A I. R E V I E W

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