Can Microfinance Reduce Poverty?
Microfinance seems to be the latest buzz word in the international development world, thanks to several high-profile micro-lending organizations and the recent string of predatory lending schemes practiced by several Western-world, wealthy lenders. Muhammed Yunus, who won the 2006 Nobel Peace Prize for his microcredit institution Grameen Bank, distinguishes between micro-lenders who are there to help the poor and those that are there only to benefit an already-wealthy set of Wall Street and international investors. The direction microfinance takes in the future will determine whether microfinance can help alleviate poverty on a large scale.
The differences between the two systems and their effects on the individual and community levels are obvious. Grameen bank, and other micro-lenders like it, is self-funded by deposits made by local community members and in the local currency, interest rates are not above 20 percent and any profit made is poured back into the community via local projects or the bank’s local members.
Microfinance institutions following the other model are created by foreign investors who charge high interest rates (sometimes as high as 90 to 100 percent), bring foreign currency and keep the profits for themselves—far removed from the poor village whose local economy could benefit from the money.
But it’s not just foreign, and arguably predatory, microfinance institutions that have come under criticism; the notion that micro-lending reduces poverty is also up for debate. A recent Brookings study argues that “there is no compelling evidence that microfinance has led to sustained poverty reduction anywhere.” The report goes on to say that the vast majority of loans function temporarily, either by filling the financing gap in consumption or “softening the blow of poverty.”
The second function–that microloans only temporarily allay the more acute symptoms of poverty for individuals–certainly seems true when one reads microloan success stories, particularly stories featuring women, who are targeted for microloans because they are more likely than men to use the money to support their children. As microfinance organization FINCA reports on its Web site, microloans gave one woman in Uganda the ability to expand her fish-selling business so she could afford to giver her children more than just two meals a day; another in Guatemala was able to expand her baking shop immensely, which in turn allowed her to employ neighbors, her older children and send the younger ones to school; a third story comes from India where a woman used a microloan to buy a rickshaw to transport her wheat to market. She saved 50 percent of her profits that otherwise would have gone to paying someone else for transportation.
This post isn’t meant to diminish the positive effects of microfinance. Often with over-arching discussions on development methods, the human element can all-too-often be forgotten. Individuals, who are focused, have a business plan and are hard working, can benefit greatly from microloans. They can educate their children, save for emergencies, expand existing businesses and seek medical help when needed, all things that they wouldn’t have been able to without loans.
However, such positive gains in individual wealth do not mean microloans can raise the entire society out of poverty. We have to be careful to distinguish between the individual and societal effects of development programs. Investors and institutions working to alleviate poverty in third-world countries on a wide scale should donate to or invest in small and mid-size businesses, which, as opposed to individual ones, can move an economy forward and create jobs that will benefit a larger portion of the population. Funding only tiny, one-person businesses will certainly help that one person and his or her family, but will not spur major growth in the local economy. The answer to pulling developing nations out of third world status is to use all the methods at the Western world’s disposal; this includes giving microloans to individuals whose children will then be able to receive an education and work toward a better life and also includes giving loans and credit to larger businesses that can employ more people, stimulate growth, attract more investments and impact the local economy.