Arnold Kling  

A Microfinance Skeptic

Holiday Reading... Which Sector Should Lead?...

A reader points me to this letter from Milford Bateman about the impact of microfinance.

first, a serious shortage of funds for small and medium-sized enterprises, which is deeply damaging because SMEs have by far the most sustainable growth and development potential. Second, thanks to microfinance there has been an accelerated proliferation of informal-sector microenterprises in Serbia over 2004-08, so the country is now chock-full of traders, kiosks, shops, street-traders and subsistence farms. The base of the economy is quite simply being destroyed.

I guess the question is whether the rise of tiny informal businesses comes at the expense of the formal economy, as Bateman claims, or whether it represents a net addition to economic activity. Conceivably, microfinance could "crowd in" rather than crowd out the formal economic sector. If it is the latter, then indeed it requires second thoughts.

UPDATE: Rafael La Porta and Andrei Shleifer find neither crowding out nor crowding in.

growth comes from the creation of the highly productive formal firms. Informal firms keep millions of people alive, but disappear over time.

Comments and Sharing

COMMENTS (9 to date)
Grant Gould writes:

Bateman complains: From almost zero in 2001, the commercial banks now channel 22 per cent of their total loan portfolio through highly profitable microfinance.

Cry me a river.

If microfinance loans are "highly profitable" -- get better risk-adjusted returns for the banks -- then that means that that "base of the economy" was simply an unproductive sink for otherwise useful capital, and can't be "quite simply...destroyed" fast enough.

I fail to see how banks finding better return on investment in micro-enterprises than in the SMEs preferred by experts constitutes a failure by anyone except the experts and the SMEs.

Bateman argues in essence that we need a cadre of terribly clever people to plan out a country's economic development and to provide sub-market-rate capital to those chosen "sustainable" enterprises. He laments that bankers are no longer taking on their white-man's-burden of picking and choosing the course of development, which failure he says is leading to "Africanization" of the country. His argument damns itself.

Alex J. writes:

The "informal economy" refers to operations that are too small for the government to tax efficiently. I'm curious as to the tax rates (and weight of regulation) in countries supposedly damaged by small businesses. Perhaps as more workers move to nimble operations the juicier targets get squeezed even more.

Bangladesh – the spiritual home of microfinance – has to rely on foreign direct investment and government spending for serious investments, since its own savings are intermediated into microfinance

Might the quality of governance in Bangladesh have something to do with the reticence of its citizens to loan money to larger enterprises? I don't believe that Bangladesh had a notably successful banking system before microfinance came to prominence.

Matt C writes:

From the article:

> the commercial banks now channel 22 per cent of their total loan portfolio through highly profitable microfinance

If microfinance is more profitable than "enterprise finance", doesn't that suggest that microfinance projects are also more productive?

Suppose that microfinance is shown to be "stealing" capital away from mid-size firms. Why would this be bad? How could we tell that it was bad?

Ed writes:

"The base of the economy is quite simply being destroyed."

To the benefit of the populace far and wide. This is only a problem for the bureaucrats and politicians who can see they are losing control as a result. I would expect microfinance to be either heavily regulated or made outlawed very soon.

Methinks writes:

Every word that Grant Gould wrote resonates with me.

My husband lived in Bangladesh in the late 80's and had the opportunity to do an in depth report on Mohamed Yunus and the Grameen Bank because his father worked with Yunus. It had such a profound impact on him that he went on to major in economics because he saw the unleashing of the power of the individual to create wealth and better his own life. Bangladesh and what passes for its mainstream economy is best described as a sewer. In the '80's Bangladesh was a dictatorship with a massively corrupt central government, an overdeveloped bureaucracy and an underdeveloped economy. Today it is a democracy with with a massively corrupt bureaucracy and an underdeveloped economy and two warring political parties who send unions loyal to them on strike every time they lose an election. At any given moment, half the country is on strike. Very productive. In my opinion, that's a system that can't be starved of cash fast enough. I can't take Bateman's opinion seriously until he is forced to live in Bangladesh as a Bangladeshi or in Serbia as a Serb.

Mick writes:

By "formal" sector you mean the businesses in favor with the totalitarian regime. Usually its the black market in those countries that actually represents the people.

floccina writes:

I like Alex J's comment and question. When I think of informal economy, I think high taxes and regulation. Now I would also add that there seems to be an optimal size to each type of business and therefore that having a large informal sector can be bad but the solution seems to be to lower taxes and get rid of bad regulations.

MP writes:

What a bunch of nonsense... I mean, I live in Serbia and if anything there was a huge reduction of informal sector in the past 8 years.

Yes, there are still some street traders and such, but much, much less than 8 or 4 years ago. Eight years ago we were buying gasoline and cigarettes in the street. Now its socks and pirated CDs.

Regarding so called "microcredits" that supposedly amount to 22% of total bank portfolio, it has nothing to do with what most people think of when they talk about micro finance. These are simple consumer loans for stuff such as furniture, computers and such things. They have nothing to do with any business whatsoever.

I'm sort of involved in the SME story in Serbia and can only say that for someone to be called "the SME consultant" usually the only prerequisite is to have an English-sounding name.

milford bateman writes:

If MP is 'sort of involved in SME development' in Serbia, then this is a huge pity for Serbia and its chances of progressing, since he/she has clearly very little real grasp of what is actually going in on his/her own country.

1. The Serbian government's in-depth Labour Force Survey for 2008 demonstrates a very clear adn worrying increase in the informal sector over just the last 4 years. This is at a time when growth was OK adn many were hoping that, finally, some formal sector growth would be coming through. Most worrying is the rise in 'one-person' microenterprises as a percentage of total microenterprises adn total employment, and also the proportion of microenterprises dependent upon 'unpaid family labour'. There is also a ton of other data from the EBRD, World Bank and Institute of Economic Sciences in Belgrade too that shows the situation is deteriorating and the informal sector is growing even more.

2. That the microloans in Serbia have nothing to do with business is precisely my point. MP clearly did not understand the point I was making. To explain - the point is that a huge portion of Serbia's valuable savings are simply recycled into household loans which have no real long term developmental impact, when they should really be channelled into projects with more liklihood of creating SMEs adn employment.

Simply to be living in a country clearly does not mean you have any idea what is going on in the local economy. Could I recommend to MP to maybe actually read something on the subject....

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