The Micromagic of Microcredit

The microcredit movement has garnered plenty of attention in recent years, and its founder -- Muhammed Yunus -- was awarded the Nobel Peace Prize in 2006. The concept is simple: small loans to third-worlders interested in beginning or expanding a small business may be the most effective way to foster economic development in poorer regions. The loans have a track record of repayment in 98% of cases and generally require a very small amount of investment (as low as $20). Some believe that microcredit loans do more for third-world development than charity or government aid since the money goes directly to those who can use it to increase growth. The legend of microcredit is so amazing that it sounds to good to be true.

Karol Boudreaux and Tyler Cowen examine the issue, and find that the commonly told story of microcredit is, in some ways, too good to be true. They find that the institution certainly has a net positive impact, but the results aren't quite so miraculous as proponents sometimes claim.

The achievements of microcredit, however, are not quite what they seem. There is, for example, a puzzling fact at the heart of the enterprise. Most microcredit banks charge interest rates of 50 to 100 percent on an annualized basis (loans, typically, must be paid off within weeks or months). That’s not as scandalous as it ­sounds—­local moneylenders demand much higher rates. The puzzle is a matter of basic economics: How can people in new businesses growing at perhaps 20 percent annually afford to pay interest at rates as high as 100 ­percent?

The answer is that, for the most part, they can’t. By and large, the loans serve more modest ­ends—­laudable, but not world changing.

Microcredit does not always lead to the creation of small businesses. Many micro­lenders refuse to lend money for start-ups; they insist that a business already be in place. This suggests that the business was sustainable to begin with, without a microloan. Sometimes lenders help businesses to grow, but often what they really finance is spending and consumption.

That is not to say that the poor are out shopping for jewelry and fancy clothes. In Hyderabad, India, as in many other places, we saw that loans are often used to pay for a child’s doctor visit. In the Tanzanian capital of Dar es Salaam, Joel Mwakitalu, who runs the Small Enterprise Foundation, a local microlender, told us that 60 percent of his loans are used to send kids to school; 40 percent are for investments. A study of microcredit in Indonesia found that 30 percent of the borrowed money was spent on some form of ­consumption.

Sometimes consumption and investment are one and the same, such as when parents send their children to school. Indian borrowers often buy mopeds and ­motorbikes—they are ­fun to ride but also a way of getting to work. Cell phones are used to call friends but also to run ­businesses.

For better or worse, microborrowing often entails a kind of ­bait ­and ­switch. The borrower claims that the money is for a business, but uses it for other purposes. In effect, the cash allows a poor entrepreneur to maintain her business without having to sacrifice the life or education of her child. In that sense, the money is for the business, but most of all it is for the child. Such ­life­saving uses for the funds are obviously desirable, but it is also a sad reality that many microcredit loans help borrowers to survive or tread water more than they help them get ahead. This sounds unglamorous and even disappointing, but the ­alternative—­such as no doctor’s visit for a child or no school for a ­year—­is much ­worse.

The whole article is not very long, and well worth reading.

Memo to Bono

Gregory Clark -- author of the notable A Farewell to Alms -- says that all the humanitarian efforts to eliminate poverty in Africa are destined to fail. A short, interesting read.

U.S. vs. Kenyan Farmers

A nice little NY Times piece which reinforces how small pieces of U.S. legislation can have dramatic effects on the developing world. Some good bits:

Families participating in an American-financed irrigation project from 2002 to 2006 were promised payment in corn for clearing the land and digging canals. The Kenyan government objected to the importation of American corn because the country was awash in a bumper harvest that had caused corn prices to plunge.

The result: American officials, prohibited by law from buying the corn locally, could not deliver it. As the impoverished families waited in vain for sustenance from the American heartland, malnutrition among the youngest children worsened and five people died of hunger-related causes.

Across Africa, the United States is more likely to give people a fish — caught in America — that feeds them for a day than to teach them to fish for themselves. Since last year, for example, the United States has donated $136 million worth of American food to feed the hungry in Kenya, but spent $36 million on agricultural projects to help Kenyan farmers grow and earn more.

And even that small budget for long-term projects in Kenya is expected to dwindle. The United States Agency for International Development, known as Usaid, in seeking to concentrate scarce resources, has dropped Kenya from the list of countries eligible for undertakings like the irrigation project here.

USAID is one of the best U.S. government agencies. They do a lot of great work -- under the radar -- in underdeveloped countries. Unfortunately, they often have their hands tied by domestic legislation which hurts foreign countries to benefit special interest groups in the U.S. The culprit this time? As is usually the case when it comes to agriculture policy, it's the farm lobby; the bloated Farm Bill prevented the government from honoring its commitment to starving Africans to provide them food, unless that food was grown in the U.S. Sounds like an okay deal, right? But the economics of this presents a harsher reality. By shipping in American corn, the price of domestic corn (in Kenya) was depressed, so local farmers had to either sell their own at deflated prices, or not sell it at all. So the net effect was that the country actually got poorer through the mechanism of our aid, and some of the people actually starved to death while waiting for the promised food. All this so that rich farming corporate conglomerates could receive huge subsidies from the U.S. public in order to grow food. A bit from the article highlighting how USAID's hands were tied:

Members of Congress who favor the current system say the support of influential commercial groups is needed to sustain political support for food aid. They warn that ill-timed purchases of food in Africa in times of scarcity could send food prices higher, harming poor consumers.

But critics in Congress contend that the United States could feed far more people more quickly if it could buy surplus food in Africa. It might also help boost the incomes of African farmers, by providing a market for their crops, they say.

The Bush administration is now trying to change the law so that up to $300 million of food can be bought in poor countries during emergencies.

The criticism of those favoring the status quo might be valid: if we buy food locally (in Africa), then the increased demand could (probably will) increase prices for everyone else. But it should also boost employment, wages, and production which should bring the market back into equilibrium pretty quickly. As the article points out later, Iowa alone got $1.58bn in farm subsidies in 2005. In other words, American farmers are well taken care of; the piddling amount that we propose to purchase in Kenya shouldn't greatly effect their bottom line.

The U.N. recognizes this; they did what USAID couldn't (but wanted to do): bought the food in Africa and gave it to the starving people.

Still the program has been a success, despite the U.S.'s backwards agro policies. Poor Kenyans now have irrigable land for the first time, and many of them are on the path to self-sufficiency. That is a good thing, but the lesson must be learned: freeing up USAID to act in the best interests of those whom they are charged with helping will have the best possible effects. This can help the U.S.'s standing as well; we may have lost the MidEast to radicalism. We should make sure that we don't lose Africa as well.