July 23, 2013
Thirty years ago, the international development community was abuzz with excitement. This was because it appeared that the perfect solution to poverty, exclusion and under-development had finally been found in the form of microcredit. As originally conceived, microcredit is the provision of micro-loans to the poor to allow them to establish a range of income-generating activities, supposedly facilitating an escape from poverty through individual entrepreneurship and self-help. Perhaps nowhere more than in Latin America was the excitement so intense. Stoked by the uplifting claims of Peruvian economist, Hernando de Soto [1], that a vastly expanded informal economy would prove to be the economic salvation of the continent, the U.S. government through the World Bank and its own aid arm, USAID, along with the Inter-American Development Bank (IDB), led the charge to establish the microcredit movement as the dominant local intervention to address poverty.
However, the sour reality that Latin America faces today is that all the excitement over microcredit was fundamentally misplaced. As I argue in a recent article [PDF] published in the Mexican journal Ola Financiera, the microcredit movement has likely proved to be one of the most destructive interventions brought to Latin America over the last 30 years. A growing number of Latin American governments and international development agencies are now finally reconsidering their once unconditional support for the microcredit model. So what went wrong? Let me point to a few of the most important problems.
First, the overarching outcome of the microcredit model in Latin America has been an increase in the supply of “poverty-push” informal microenterprises and self-employment ventures. Yet rather than creating a De Soto-esque foundation for rapid growth and poverty reduction, the very worst possible foundation for promoting long-term poverty reduction and sustainable development was created. As economists such as Alice Amsden, Robert Wade and Ha-Joon Chang have convincingly shown, the now wealthy developed countries and the East Asian “miracle” economies found that what is really needed to escape poverty is for the state to engineer an entirely different constellation of the “right” enterprises: that is, enterprises that are formalized, large enough to reap important economies of scale, can innovate, can use new technology, are willing to train their workers, can supply larger enterprises with quality inputs, can facilitate new organizational routines and capabilities, and can eventually export. Economic history shows, too, that financing the expansion of the “wrong” sort of informal microenterprises and self-employment ventures will simply not lead to sustainable development. As Ha-Joon Chang brilliantly points out, Africa has more individual entrepreneurs than perhaps any other location on the planet, and many more are being created all the time thanks to rafts of microcredit programs backed by the developed countries, yet Africa remains in poverty precisely because of this fact. Likewise in Latin America: by programmatically channelling its scarce financial resources (savings and remittances) into informal microenterprises and self-employment ventures, and so away from virtually all other higher-value uses, the continent has actually been progressively destroying its economic base.
Mexico exemplifies the microcredit trap created in Latin America. Its financial institutions have all proved to be adept at channelling their funds into hugely unproductive and all too often temporary informal microenterprises and self-employment ventures – so-called “changarros” – leaving the bulk of potentially growth-oriented, but low profit and high risk, small and medium industrial enterprise projects increasingly without financial support. Over the last two decades this “crowding out” trend has undoubtedly undermined Mexico’s once powerful industrial and technological base.
A very similar story emerged in Bolivia since the 1980s, where the U.S. government-supported push for microcredit has played a not-unimportant role in gradually destroying an economy that was once slowly industrializing under Import Substitution Industrialization (ISI) policies. Essentially, Bolivia’s carefully built-up raft of efficient industrial small and medium-sized enterprises was starved of funding and left to collapse. Resources were instead shifted into promoting the hugely unproductive and no-growth informal microenterprise and self-employment sector, which has, not surprisingly, dramatically expanded in recent years. Today, with nearly 40 percent of Bolivia’s financial resources now independently intermediated into these “wrong” sort of (micro)enterprises, the Bolivian government has its work cut out to try to stop the damaging de-industrialization trajectory underway in the country.
The second key problem with the microcredit model in Latin America arises from the fact that in the neoliberal 1990s it was aggressively commercialized and extensively deregulated. The primary motive for this move was to eradicate all government and international development community subsidies from the world of microcredit. The use of subsidies (typically to maintain low interest rates) was felt to be ideologically suspect by the main U.S.-based international development agencies, and it was also thought to unjustifiably add to the tax burden on business elites. With extensive advice and financial support provided by USAID, Bolivia was turned into the “best practice” example of commercialised microcredit, thanks mainly to BancoSol, the world’s first dedicated commercially-driven microcredit bank. Yet turning microcredit into a for-profit business under minimal regulation has proved to be a singular disaster: spectacularly damaging levels of Wall Street-style greed, profiteering and financial market chaos soon ensued. Microcredit effectively became the developing world’s very own version of the USA ’s sub-prime lending crisis.
In Bolivia, the commercialization of microcredit has been a major development disaster for the poor. First, Bolivia’s scarce financial resources were disastrously shifted into the “wrong” enterprises, as I just pointed out. Commercialization also directly precipitated the “microcredit meltdown” that Bolivia experienced across 1999-2000, an event that inflicted very serious long-term damage on the Bolivian economy. Crucially, however, commercialization has been a massive success for those managing and investing in Bolivia’s microcredit institutions. The elite group of individuals involved in running Bolivia’s main microcredit institutions, famously including BancoSol and its predecessor, PRODEM, have all become very rich indeed. High salaries, bonuses and dividends have been important to those most closely associated with the management and ownership of BancoSol. The first employees in PRODEM, an institution that has its origins as an NGO funded by the international community to “help the local community,” eventually made millions of dollars after they gradually took control of PRODEM and then brazenly sold it off to a Venezuelan bank. We should, of course, not be surprised to find that little trust, respect or solidarity exists between Bolivia’s poor and the microcredit sector supposedly established at great expense to help them.
Mexico’s experience also exemplifies the tremendous damage wrought by the commercialization of microcredit in Latin America. Even more so than in Bolivia , it is not the poor that have been benefitting from the increased supply of microcredit, but a small financial elite that has been quietly profiteering to a simply stupendous extent. Probably the best/worst example here is that of Banco Compartamos, an organization founded in 1990 as an NGO and making extensive use of international donor grant funding. Even with laudable goals written into its founding articles, very early on it became clear that the main intended beneficiaries of Compartamos’s operations were going to be its senior staff. After 2000, for example, the senior staff began to reward themselves with Wall Street-style salaries, bonus packages and cheap internal loans which allowed them to buy shares in Compartamos. Then in 2007, when Compartamos underwent the inevitable IPO, key senior staff really hit the big-time, with a number of them pocketing several tens of millions of dollars when they off-loaded their shares into the market. A number of external investors also made vast fortunes from their shareholdings in Compartamos, notably the Boston-based microcredit advocacy and investor body ACCIÓN, which saw an initial $1 million stake in Compartamos (of which $800,000 was actually a grant to ACCIÓN) rise in value to nearly $270 million. Note also that Compartamos generates the revenues to support such high financial rewards to senior staff by charging as much as 195 percent real interest rates on its microloans to mainly poor Mexican women.
Inevitably, the supply of microcredit has begun to reach its saturation point in Mexico. Compartamos’s growth has been nothing short of dramatic, while many other domestic microcredit institutions have also grown very rapidly. Compartamos has been the world’s most profitable microcredit institution for five of the past six years, and its nearly $100 million dividend payout to investors is now larger than the balance sheets of most other microcredit institutions. With such huge financial rewards made possible by lending to Mexico’s poor, the big profit-hungry international banks, such as Citigroup, have entered the market, clearly adding to the lending frenzy underway. However, real fears exist that Mexico cannot now avoid a destructive sub-prime-like “microcredit meltdown” episode not unlike the one that hit the Indian state of Andhra Pradesh in 2010. Indeed, it is well known that multiple lending to households has begun to reach epidemic proportions in many parts of Mexico, especially in the massively over-supplied state of Chiapas.
Nevertheless, the question remains: has microcredit in Latin America in general, and Compartamos specifically, been helping the poor to escape their poverty? If the answer is broadly positive, then the spectacular financial rewards accruing to the providers of microcredit might be justified to an extent if meaningful benefits are accruing to the recipients – the poor. However, the unpalatable answer to this question is a resoundingly negative one: there is not a shred of real evidence to support the claim that Compartamos’s microcredit activities have played a role in resolving poverty. First consider that a U.K. government-funded study of virtually all previous impact evaluations of microcredit dramatically showed there is no empirical evidence anywhere [PDF] to show that microcredit has had a positive impact on poverty. Even long-standing supporters of microcredit now accept this extremely unpalatable fact.
More specifically, consider the findings of a just-released impact evaluation of Compartamos [PDF], financed by Compartamos itself and centrally involving one of the most high-profile microcredit supporters, professor Dean Karlan, who is based at Yale University in the U.S. In spite of Comapartamos’s huge presence in poor communities across Mexico, and its previous claims to be greatly helping Mexico’s poor, the impact evaluation team could only come up with a tiny amount of evidence of any positive impact arising from its activities. This was bad enough. But this tepid conclusion actually hides a much more disturbing fact, which is that the research team could only manage to arrive at this sliver of good news by effectively refusing to adopt/adapt an evaluation methodology that would capture the most important downsides to the microcredit model. One can only presume that this was felt necessary in order to ensure that they could come up with the required (very limited) positive impact result they later disingenuously claimed to have found, and which allowed Compartamos and other institutions involved to inevitably spin into the specious claim that Compartamos “generally benefits (its) borrowers”.”
Notably, the research team entirely overlooked so-called “displacement” effects – that is, the negative impact on incumbent microenterprises in the same community that lost business and income thanks to waves of new Compartamos-supported microenterprises. With most Mexican communities for a long time adequately served by simple informal microenterprises providing retail and other services to the poor, the arrival of rafts of new microenterprises operating in exactly the same sub-sector will inevitably have precipitated very large displacement effects. But these downside impacts were ignored. The team also failed to factor in the impact of exits, which is when a microenterprise fails – which the vast majority actually do, and usually very quickly – and the hapless individuals involved then have to either divert other funds (pensions, remittances, savings, etc.) to continue to repay their microloan, or else they lose assets lodged as collateral when they are forced into outright default.
But perhaps the most egregious downside impact ignored by the research team relates to the fact that they also chose to examine a very short and unrepresentative time period – introducing microcredit into a community where before there was none. This then allowed them to simply aggregate the short-term results in such virgin territory into a generally upbeat assessment of the longer-term impact. This is utter nonsense. By doing this, the research team chose to ignore, first, the fact that Compartamos has contributed to further inflating Mexico’s already over-blown and massively unproductive “changarros” sector, which a growing number of analysts now accept is creating an existential threat to the Mexican economy. Second, there was also no comment on the huge opportunity cost involved when scarce funds are gradually diverted away from the “right” enterprises. This silence prevailed in spite of the fact that even the neoliberal-oriented IDB had the guts to publicly admit in 2010 that this “crowding out” issue actually lies at the heart of Latin America’s recent history of poverty and exclusion. Third, you will find nothing in this impact evaluation that discusses the over-indebtedness problems that are clearly looming on the horizon for Mexico’s poor communities, and particularly for many of Compartamos’s long-standing clients.
The Latin American economies have all been ill-served by the microcredit model, which has provided, and continues to provide, a serious headwind to those governments in Latin America hoping to escape once and for all from poverty, exclusion and primitivizing development trajectories. That microcredit continues to attract such support today thus needs some explanation. I would argue it is down to two factors. First, the politics and ideology; principally the need by the U.S.-led international development community to ensure that individual entrepreneurship and self-help remain the only potential paths out of poverty for the poor in Latin America, and not the exercise of any form of “collective capabilities” through social movements, trade unions, pro-poor governments, or any other similarly “subversive” intervention that the poor might wish to collectively deploy to escape their poverty, and might even have voted for as part of the “pink tide” of leftist governments. Second, there is the issue of the massive wealth that a tiny financial elite has been able to generate for itself thanks to (over)lending to the poor, and which it is now, quite predictably, unwilling to forego. This wealth has allowed, among other things, for the microcredit industry to aggressively lobby governments, mount massive PR campaigns and effortlessly finance deliberately dodgy impact evaluations, all in order to persuade the key actors in Latin America to continue to support the microcredit model.
All told, Latin American governments urgently need to disentangle themselves from the egregious myths and neoliberal-inspired fantasies surrounding microcredit, and begin to completely re-think their (often imposed) allegiance to what has proved to be an ultimately destructive poverty reduction and local development model.
Milford Bateman is a freelance consultant on local economic development and also, since 2005, a Visiting Professor of Economics at Juraj Dobrila at Pula University in Croatia.
[1] Hernando de Soto (1986): El otro sendero: la revolución informal. Lima: ILD
