During the early 1980s as unemployment in the Coal fields and Steel towns of the UK grew, many miners and steelworkers ploughed redundancy money into small businesses such as taxis and hairdressing salons. It was enterprising – to a point – but made little contribution to the need for sustainable growth fuelled by innovative and productive SMEs.
Then, as now, it begs the question whether everyone is capable of being an entrepreneur. Often, this laudable mantra serves to fragment increasingly scarce credit facilities at the expense of loans to fewer, better quality business models. As the current recession deepens the impact of starving SMEs of much needed finance has strong parallels with the impact of microcredit and developing economies where rickshaws and kiosks proliferate when SMEs are the real route to sustainable growth.
In a letter to the Financial Times (December 20, 2008), Dr Milford Bateman highlights the impact microfinance is having on local economies in the Balkans. His thoughts are relevant to a wider audience.
Working in Serbia, he highlights the explosion of microcredit programmes within commercial banks from almost zero in 2001 to 22% of their total loan portfolio through highly profitable microfinance (loans to homes) programmes amounting to almost 12% of GDP. This has led to a serious shortage of funds for SMEs – which have the best chance of sustainable growth potential. Also, these small loans have accelerated proliferation of informal sector microenterprises (2004-08), such as kiosks, street-traders and subsistence farms. This is destroying any chance of developing an SME based economy.
His insightful letter then goes on to highlight Bosnia as an even worse case. Bosnia is serving as the international community’s “test bed” for post conflict micro finance. Informal businesses grow and, SMEs are choked througha lack of available funds. Locals are calling this “Africanisation” (Africanizacija); a planned descent into unsustainability.
Perhaps his most dramatic illustration of this phenomenon occurs in Bangladesh, through Yunus’s Grameen Bank, the spiritual home of microfinance. Here, any serious projects to build local infrastructure or fund productivity enhancing assets flounder because available savings in the system are channelled into microcredits that lead to a proliferation of rickshaws, kiosks, street food sellers and traders. The same is happening in Mexico where investors are making significant returns on shares in microfinance companies such as Compartamos – the subject of a ground breaking IPO.
Such an obsession with microfinance is contributing to the growth of informal businesses and a complete dependence on foreign direct investment for anything that can make sustainable improvements. Why? Because any increase in local savings is being channeled into the micro credit sector and a clear focus on fragmented small loans instead of more productive quality investments. It is estimated that the microfinance industry covers $15 to $25 billion in loans though the demand for loans of this type is estimated at $300 billion. Worse, it encourages people to enter into overcrowded niches in the business landscape and dilutes their collective impact in price wars that send them all into commodity trading rather than added value enterprise. Elsewhere, Dr Bateman has referred to this as the bazaar economy. Crucially, this means a non-industrial future that will guarantee nothing more than unending poverty.
Microcredit has made some enormous contributions to the development agenda but, blind adherence to the credo of microcredit destroys the opportunity to work on logistics initiatives and investment into materials handling equipment to improve productivity across the board. And it may be contributing to PR that implies progress when the reverse is the case. Dr Bateman concludes that this is why many East Asian countries may have started at the same GDP levels as Bangladesh in the 1970s but have since then massively outpaced Bangladesh in terms of growth and development. Aneel Karnani supports this view in his article – Microfinance misses its mark.
This observation on micro credits is echoed in a recent World Bank report – Who gets credit? which shows that economies benefit more when money is lent to firms rather than households. In fact, micro credit is far from a universal panacea for post disaster redevelopment or, as a means to bridge the gap between the informal and formal markets.
Note: Have a look at this excellent review of the literature on microfinance by Stanford Social Innovation Review:
Maybe there is a new iron law emerging – As the quantity of micro loans rises the quality and sustainability of growth declines. Discuss.