An Examination of the Microcredit Movement

By Jason Meade

“One day our grandchildren will go to museums to see what poverty was like.”
- Muhammad Yunus, founder of the Grameen bank, quoted in The Independent 5 May 1996

This essay will examine the microcredit movement. It will begin by explaining what microcredit is and how it functions. Microenterprise clusters will also be defined. Some background on the current state of the microcredit movement will then be given. The second section of the essay will look at the benefits of microcredit and the advantages of clustering microcredit financed enterprises. The third section will look at the problems associated with microcredit and microenterprise clusters. The essay will conclude with an analysis of the net effects of microcredit and give some idea of its prospects for reducing world poverty.

I. Definition and Background

Definition

“Microcredit” is the name given to extremely small loans made to poor borrowers. A typical microcredit scheme involves the extension of an unsecured, commercial-type loan at interest to a poverty stricken borrower. The definition of poverty stricken varies with the situation, but in Bangladesh the typical definition is a borrower who owns less than 0.5 acres of land and relies on wages for all income. Loans are disbursed in a group setting to poor borrowers, with some amount of non-credit assistance also being made available. The non-credit assistance typically ranges from skills training to marketing assistance to lessons in social empowerment. (Khander, 1998)

Most microcredit programs are set up in the following way (description taken from “New Study Confirms Benefits of Bangladesh’s Microcredit Programs”, 1998). Credit services are targeted to landless or assetless borrowers, the moderately to extremely poor. Borrowers are placed into groups of 10-20 people which meet regularly with the loan officer of the microcredit program. These groups of borrowers substitute for collateral and take over the role of securing the loans dispersed. Each borrower in a group agrees to be held liable for all debts incurred by any member of the group. In the event that a borrower defaults, the other members of the group are required to make up the amount in default. Borrowers are encouraged or even required to monitor the behavior of one another to make sure that no one is danger of default. This process has led to extremely low rates of default, especially for first time borrowers. Repayment rates are usually above 95%.

Extremely small business ventures, such as those financed with microcredit loans, are known as microenterprises. Microenterprise clusters are simply groups of microenterprises located in close proximity to one another and engaging in similar business activities. The beenfits of clustering will be outlined in a later section of this essy. Clustering can either arise spontaneously, or as a result of outside encouragement from government or NGO’s.

Background

Most microcredit programs target women as the most desirable borrowers. This is partly a result of a policy of social empowerment and partly as a result of the perception that women have higher rates of repayment than men. As noted above, loans are usually collateral free. Maturity is normally 50 weeks with repayment in weekly installments. All financial transactions are conducted in the presence of the entire borrowing group and all transactions are recorded in individual passbooks. Most microcredit programs begin with small loans, but allow borrowers to take more and more as they repay each previous loan and thus prove themselves good credit risks. Finally, borrowers have full freedom to choose the activities to be financed. Loans need not be spent only on investment; spending for consumption is equally acceptable.

In broad terms all microcredit programs are working towards the goal of decreasing income poverty and decreasing the vulnerability of the poor. Microenterprise clusters claim to enhance these effects by improving on the microcredit strategies. According to the supporters of microenterprise clusters, clustering can solve many of the problems associated with microcredit financed enterprises such as distance from markets and inefficiency.

The origin of the microcredit movement is usually attributed to the work of Muhammad Yunus’ Grameen Bank which was founded more than 20 years ago in Bangladesh (Jolis, 1996). Today microcredit and microenterprise programs can be found throughout South and Southeast Asia, many parts of Africa and Latin America and even in the US and other Western countries. Support for such programs has been on the increase in recent years and there is a lot of optimism about the capacity of microcredit to reduce poverty. To quote from The Independent again (5 May 1996), “Muhammad Yunus believes that he can eradicate world poverty, all by the use of one simple idea. Now the world’s leaders are starting to take him seriously.” This essay will try to determine whether such belief and optimism is warranted.

Lastly, it should be noted that despite the spread of microcredit programs and their growing popularity with policy-makers, hard data is somewhat lacking. There is little standardization across studies as to how to define critical processes and measures of success. The definition of “poverty”, and especially “reductions in poverty”, tends to vary from study to study. “Women’s empowerment” is another very nebulous term. Many terms and processes are redefined on an ad hoc basis each time a new study is conducted. Much of the literature on the subject of microcredit appears to be in the stage of empirical observation and anecdotal evidence. However, after 20 years the preliminary results are in. There is plenty of information on the positive and negative aspects of microcredit programs, as well as some early information on the long-term effects and prospects of microcredit and microculstering schemes. This information should be more than enough for the purposes of this essay.

II. The Benefits

The main benefits of microcredit claimed by proponents are

1. a reduction in vulnerability to adverse circumstances on the part of the poor,
2. an increase in consumption in the same group, and
3. a reduction in income-poverty. The supporters of microenterprise clusters further claim that clustering increases the chances of success and prosperity for poor loan recipients.

Reduction of Vulnerability

One of the most important benefits of microcredit programs is its ability to reduce vulnerability among the poor. This reduction occurs through a number of different channels (Zaman, pp.1,18). Microcredit programs help borrowers to insure themselves against crises by building up household assets. Such assets can be sold if needed. They can also be used as security or proof of credit worthiness when dealing with businessmen or more traditional lending agencies. Finally, the diversification of assets can reduce the risks of catastrophic loss. For example, a family which relies on share-cropping could easily be bankrupted by a single crop loss, whereas a family with a diversified base of crops and livestock or handicraft income could survive until the next harvest. Other aspects of microcredit programs such as skills training and female empowerment also contribute to a family’s ability to cope with crises by increasing the variety of responses a family can make to a challenging situation.

These reductions in vulnerability are important because they allow poor people to begin to hold their own in society. Gains made in prosperous times are partially protected during bad times, and the cycle of poverty is arrested. This is really a vital benefit for the great numbers of poor people who live in rural, agricultural areas. To quote Zaman (2000), “seasonal deficits play a key part in the poverty process in Bangladesh.” The same is true in many other parts of the world as well. The relative abundance at harvest time, which derives both from the sale of crops and the increased demand for labor is usually more than matched by the poverty of rest of the year. The introduction of natural disasters into the equation tends to make the situation even bleaker for the poorest members of a society. So the beneficial effects of microcredit on vulnerability are quite pronounced.

Increased Consumption

Another benefit of microcredit programs is the increase in household consumption. One researcher in Bangladesh (Khandker, pg.148) has found that for every 100 taka (the unit of currency in Bangladesh) lent to a female borrower, household consumption rises by 18 taka. Other researchers (Zaman, pg. 4) have found that income smoothing, which is the result of lessened vulnerability, also leads to consumption smoothing. These are both important effects for people who typically live on the edge of disaster. Even small increases in consumption and increased regularity in consumption can lead to better health and nutrition, and enhance the ability to make long range plans for the family. Combined with the investment possibilities opened up via additional loans from the microcredit program, such stability can have a far reaching positive effects on participating households.


Reduced Income Poverty

Microcredit programs also reduce income poverty. That is, borrowers actually tend to make more money over time. Once the cycle of poverty has been arrested and some stability provided, many borrowers go on to make profitable investments and even lift themselves out of poverty all together. Members of the Bangladesh Rural Advancement Committee (BRAC) can expect to see their poverty fall by an average of 15% after three years of participation. The so-called “ultra-poor” experience poverty reductions of 25%. 21% of the members of the Grameen Bank (GB) microcredit program lift themselves from poverty within four years of joining the program. About 5% of the GB’s members rise from poverty each year. (Khander, pp. 2,69). Although there is a great deal of variability among microcredit programs, these results are not unusual. A rate of reduction of poverty of 5% per year is very good, and certainly seems to warrant optimism. But, it will be shown that this indicator of success is somewhat misleading.


Microclusters

Finally, there is the question of microenterprise clusters. The main selling point for clustering is the “collective efficiency” which it produces. Microcredit funded business ventures are frequently plagued by the problems of small size and isolation. It is not worth the time of itinerant traders to work with such ventures. Consequently, the ventures can only rely on local patronage, which may or may not be enough to support long term growth. With microcredit clusters however, these problems are partly overcome. Traders are attracted by the possibility of making cheap, bulk purchases. Vendors of raw materials are also attracted by the possibility of making bulk sales. The close proximity of a number of businesses in the same line of work also allows for labor sharing, order sharing, and subcontracting within a cluster. Successful clustered enterprises may also go on to specialize, with the resulting benefits that come from division of labor. It should also be noted that microenterprise clusters still tend to be more successful when they are located near roads or crossroads, even given the increased attraction associated with clustering. (Weijland, pp. 18-19)

Supporters also point to the ease of sharing information and technological innovations within clusters as other major advantages. Finally, rural microenterprise clusters have been found to have certain competitive advantages over more centrally located industries that do not have the benefit of clustering. Rural clusters usually have flexible to non-existent rules for land use and environmental impact. Labor is also cheap, flexible, and unregulated. Finally, certain raw materials such as wood or bamboo are also frequently available either for extremely low prices or for free. (Weijland, pg. 17)

To sum up, both straight microcredit programs and clustered microenterprise programs offer a number of benefits to participants. They have been successful in lifting some people out of poverty, and arresting the slide into further poverty for others. Based on the facts given above, there seems to be ample reason for optimism. However, as the next section will show, microcredit programs have a number of drawbacks which can reduce and even negate their positive impact.

III. The Drawbacks

There are a variety of problems and shortcomings associated with the microcredit and microenterprise cluster models of poverty alleviation. One is the problem of using the loans effectively. A second problem is that microcredit loans don’t reach the poorest of the poor. Instead they tend to reach the moderately poor members of society. A third problem is the danger of borrowers becoming dependent on microcredit, rather than using it as a means to escape poverty. Fourth, successes in poverty reduction may not hold up over time.
Clustering brings with it a different set of problems. The inability of some clusters to progress beyond a very rudimentary stage and the related problem of the development of a parochial world view inside clusters will be looked at. The significant issue of negative externalities will also be reviewed.

Problems of Microcredit

1. Turning a Profit on the Loan

One of the most fundamental problems with microcredit programs is the difficulty involved in actually turning a profit on the loans. In the first place, borrowers must bear not just the cost of the loan and interest payments. They must invest a significant part of their time in group activities mandated by their programs. In addition, women in many traditional societies must bear the stigma of being under the authority of a male (the loan officer) who is not a family member, and of engaging in work outside the home. Also, the loans usually finance some type of “women’s work” which is not seen as fit for men to do. This leads women to rely on their female children for supplemental labor, and thus female children are under increased pressure to stay out of school so that they can help contribute to the family income. (Khander, pp. 57, 59)

Investments may not turn a profit. In this event the money to repay the loan must come from reduced consumption or borrowing from some other source, usually on worse terms. Another problem is capture of the loans by male relatives. In some cases, male relatives use female borrowers as fronts to get relatively low interest loans. These loans may or may not be used to benefit the family, and the female borrowers rarely see any benefit at all. And yet, the women are still held responsible for repayment of the loans. (Mayoux, 1997)

Indeed the chances of a female-headed enterprise succeeding at all are often quite small. The experience of microentrepreneurs in Botswana is illustrative. Seventy-five percent of the people engaged in informal sector business activities are women. A majority of their microenterprises never grow.

They either fail completely or remain at the initial stage of street vending. ...in Botswana, Kenya, Malawi, Swaziland, and Zimbabwe most enterprises that started with 1-4 workers never expanded. (Ntseane, 2000)

Women are legally perceived as minors. They are not allowed to take out ordinary bank loans without the signature of absent, migrant laborer husbands. And even when women do manage to start small businesses they must continually fight against a repressive patriarchal social structure, and make do with what little schooling they may have received before going into business. So it is plain that making use of a microcredit loan is not as easy as some supporters would make it sound.

One final obstacle to turning a profit is the fact that as microcredit programs become more successful and hand out more loans, more people enter the local marketplace as microentrepreneurs. Nan Dawkins Scully (2000) writes that

The cumulative effect of rising costs, declining demand, and competition from both cheap imports and increased entrants into the sector leads to shrinking profits in informal-sector trade. In Zimbabwe for example, women traders in the informal sector experienced significant declines in income following the implementation of structural adjustment, and new entrants into the sector reported earning less than they had previously earned in their formal sector jobs.

In other words, the initial success of microenterprises can lead to subsequent overcompetition problems, especially when international trade liberalization is factored into the equation. A few microentrepreneurs in a given area may be able to turn a profit. A large number probably can not.

2. Inability to reach the poorest of the poor

A second important drawback to microcredit programs is that they don’t reach the poorest members of the society. To quote “Assessing the Poverty and Vulnerability Impact of Micro-credit in Bangladesh” (pg 4), “the poorest have a number of constraints (fewer income sources, worse health and education, etc) which prevent them from investing the loan in high-return activity” The same report also writes that “there appears to be a growing consensus that moderate-poor micro-credit borrowers benefit more than extremely poor borrowers.” The reasons for this are clear. The poorest need tiny loans which are not cost effective even for microcredit programs. The poorest also place the greatest demands on microcredit training programs, which makes the cost of lending even higher. As microcredit programs are pressured to become more self-sufficient, the incentive to lend to such desperately poor borrowers evaporates. (Mayoux, 1997)

This is a major problem for microcredit programs. Although they are raising some people out of poverty and keeping some people from further poverty, they do not appear to be reaching the people who need assistance the most. In fact, such programs may even be increasing the chasm between the poorest and the rest of society. This is clearly a failure for programs whose avowed purpose is to narrow the gap between rich and poor, and raise up the poorest members of society.


3. Microcredit dependency

Another possible failure of microcredit programs lies behind seemingly benign statistics. Some researchers have proposed the idea that the high repayment rates, repeated borrowing, and low drop-out rates indicate a dependency on microcredit programs rather than an attraction to successful microcredit programs on the part of poor borrowers. Many borrowers have no alternative to borrowing from microcredit programs, and consequently can not afford to default. Neither can they afford to stop borrowing or drop-out of the programs. There is nowhere else for them to go. (Khandker, pp.160,166) In order to stay in good standing with the microcredit program, borrowers may even be forced to resort to pawnbrokers or other alternate sources of funding. Furthermore, unless borrowers can increase their incomes they may become permanently dependent on microcredit lending (Khandker, pg.166). This a very real possibility as was noted above.

Again this is a significant failure, as many microcredit programs tout themselves as more progressive alternatives to the existing systems of informal credit which have caused so many problems in poverty stricken areas (systems such as share cropping, debt bondage, and so on). The chances of microcredit programs becoming just another form of debt-based oppression is real and must be addressed before microcredit programs can progress much further. And yet it has hardly been discussed up to this point.

4. Durability of poverty reduction

A related problem is the durability of poverty reduction. Infusions of cash in almost any amount are bound to have some effect on the poverty stricken borrowers. But this does not necessarily mean that the effect will be permanent. The poverty reductions may be rolled back in two ways. First of all, borrowers may use loans for consumption purposes which result in a momentary increase in living standards, but which must be paid for by cuts in future consumption. (Zaman, pg. 23). Secondly, borrowers must make a net profit on their investments. Otherwise, as noted above, they may become dependent on the creditor programs. Even if they do not become dependent on microcredit lenders, they will still have failed to improve their economic position. Again, this would be a failure of microcredit lenders to achieve their goals.

Problems of Microenterprise Clusters

1. Cluster stagnation

One of the biggest problems in microenterprise clusters is the inability to progress. it is relatively easy to begin a cluster. Typically, a group of craftspeople will simply set up shop near each other, with each handling the entire manufacturing process for the goods being produced. And, the goods will usually be fairly simple- textiles, baskets, roofing tiles, etc. This is enough to draw in suppliers and buyers. The problem is that many clusters do not progress beyond this stage. Ideally, clustered producers should specialize over time, but this does not always happen. Speaking of the situation in Africa Dorothy McCormack writes that “clustered producers can only advance when there is both a demand for higher quality goods and the availability of the technology to produce such goods.” (McCormack, pg. 1545) All too often one, or both, of these conditions is lacking. Consequently, clusters may stagnate and or even collapse.


2. Parochialism

Another problem is parochialism within the clusters. Clusters tend to center on interactions within the cluster at the expense of outside interactions. So for example, businesses in a cluster may monitor one another and adopt new techniques developed within the cluster. It is less common for clustered businesses to follow the same process when it comes to outside innovations. Even when outside innovations are introduced into a cluster they may be met with suspicion. (Visser, pg. 1566) This is can become a fatal flaw when clusters are forced into competition with more advanced foreign producers. Researchers in India found that clustered firms which did not step up cooperation with outside entities (such as retailers) in the face of increased foreign exposure did not fare as well as those that did. (Visser, pg. 1554) Many such firms went out of business altogether.


3. Negative externalities

A final drawback of clustering microenterprises is the concentration of negative externalities. In one African study (McCormack, pg.1531), the effect of clustering on labor supply and wages was extremely negative. So many unskilled workers were drawn to the cluster that labor competition became intense and wages were severely depressed. Another example of negative externalities was identified in a collection of Indian leather tanners in clusters. (Kennedy, pg. 1673) The concentration of enterprises led to unacceptably high pollution levels and entire clusters were shut down based on the aggregate pollution levels of each one.

So, it is clear that both microcredit programs and microenterprise clusters have a number of drawbacks that tend to reduce the positive effects they are intended to produce. The questions ahead are: 1. do microcredit programs have a positive net benefit?, and 2. how effective are they in the campaign to reduce world poverty? Are they going to put poverty in the museum, as Dr. Yunus would have us believe?

IV. Analysis and Conclusions

This section will first address the effectiveness of microcredit in alleviating poverty and improving the status of women in existing programs (since women are the target population). It will then look at the question of whether implementation of microcredit programs on a wider scale could have a significant impact on overall global poverty. Finally, it will conclude by suggesting that microcredit programs do have some value, but can not have a significant effect by themselves owing to the multiple causes of poverty around the world.

Poverty and Women in Current Microcredit Programs

As was stated above (section II. C), microcredit programs can lift as many as 5% of program participants out of poverty every year. Unfortunately, this figure fails to mention that, in Bangladesh for example, microcredit programs only reach about 20% of the population. Therefore, only about 1% of the population can rise from poverty each year under microcredit programs. (Khandker, pg. 73) And at the same time that this 1% is rising from poverty, the population is increasing by 1.8% per year, predominantly in the poorer classes. So the net effect is to hold poverty at bay rather than to roll it back. There is also a further concern. Either an increase in the rate of population growth or a decrease in the success rate of existing programs could erase the poverty alleviation progress that has been made to date. Similar situations exist in most areas where microcredit programs are active, so the tenuous nature of microcredit-based economic improvements can not be ignored.
Microcredit’s track record in the area of female empowerment is equally mixed. Some studies have found a strong correlation between participation in microcredit schemes and female empowerment. They attribute this to the self-confidence women gain from handling money, operating independent businesses, and earning money for the family. Others point to the paternalism of lenders and tendency for loans to be captured by men as factors which tend to negate any empowerment which might be going on. They also point to the selectivity problem. This is the problem of determining whether women who appear to be empowered joined a lending scheme because they were empowered, or became empowered as a result of their participation. These questions have yet to be resolved either way.

Microcredit is also a mixed blessing for women in the sense that even when women do increase their incomes, the increase comes at the expense of their time and that of their female children, as mentioned earlier (section III.A.1). So in some cases microcredit may be doing nothing more than pioneering new routes to the same old destination of female subordination. Microcredit may even worsen the situation if women must work harder to maintain the same low social status and lack of education they have always had. The prevailing wisdom in microcredit circles holds that women are more helped than harmed by microcredit, but this wisdom is increasingly being challenged as programs are examined more closely.

Spreading Microcredit Programs

Microcredit programs are not suited to all poor people equally. Poor people with good oral math skills tend to participate more in microcredit programs, while those with poor oral math skills tend to gravitate towards subsidized wage employment programs, such as public works projects. Studies also suggest that the poorest of the poor are more likely to seek subsidized wage employment when they want to improve their economic situations. (Khandker, pp. 155-6)

These findings suggest that microcredit programs alone will never succeed in solving the poverty problem. Any solution that is unable to reach the very poorest members of society will never be a complete solution. A realistic attack on poverty must use a number of different tactics. These should include subsidized wage employment programs, in addition to subsidized business start-up programs. Food assistance, health insurance, and legal education have all also been recommended as necessary components of any comprehensive program. (Zaman, pg. 25) Finally, one recent study (Khandker, pg. 156) found that investment in infrastructure improvements was at least as cost effective as microcredit in increasing consumption among the rural poor. Therefore, it is clear that microcredit programs do not warrant consideration as the only solution to the poverty problem. They may not even warrant a place at the center of poverty alleviation schemes.

There is one further argument against extending the reach of microcredit programs. As Nan Dawkins Scully (2000) writes

Since a majority of people have neither the skills nor the inclination to be entrepeneurs, why are microenterprises proliferating? It has been clear for decades that the informal sector is a depository for the victims of the failure of the formal sector.

She goes on to point out that microcredit programs are frequently used as a substitute for meaningful social reform. It is true that microcredit and microenterprise cluster programs can help some people, and can even lift people out of poverty. However, this essay has shown that microcredit is not a cure-all. It can try to hold the line against poverty, but there is still no record of microcredit schemes rolling back poverty anywhere in the world, even after more than 20 years of continuous and expanding operation in some areas.

The absence of serious social reforms probably guarantees continued poverty in large parts of the globe, no matter how many microcredit loans are disbursed. As the experience of women in Botswana demonstrated, social and institutional impediments can cause serious problems. Land reform and gender equality would probably be more effective in reducing poverty than microcredit could ever be. Among the options already mentioned, improving infrastructure would probably be a more durable method of poverty alleviation.

Conclusions

Microcredit and microenterprise clustering have some merit within certain narrowly defined limits. They can be a great help to poor people with good math skills, and some predisposition for entrepreneurship. Such programs are especially helpful for the moderately poor, and for enterprises located near roads and crossroads (as noted above in section II.D). Successful microentrepreneurs also need to be able to choose good, money making investments, and be able to pursue them without undercutting from other microentrepreneurs or cheap imports. Finally, if the enterprises are going to be encouraged to cluster they must not be of a kind that is likely to produce large negative externalities.

With all of these restraints and qualifications, it should be obvious that microcredit programs are not going to be solving all of the world’s poverty problems. If our grandchildren go to museums to see what poverty was like, it is not going to be as a result of the spectacular success of expanded microcredit initiatives. The problem of poverty is too multi-faceted. It just can’t be addressed by a single solution. Microcredit will never have significant impact on the world-wide phenomenon of poverty.

That being said, microcredit can still have a place in the arsenal of poverty reducing techniques. While not every poor person is a budding entrepreneur, it is still true that some of them are. In Bangladesh, as much as 1% of the population is composed of new entrepreneurs working their way out of poverty each year (see section IV.A). This is better than nothing. The fewer people in poverty, the easier it will be to tackle to problem.
Also, the accumulating observations of differences within the mass of poor people can be put to profitable use. While microcredit might be increasing the divide between the extremely poor and moderately poor, it is also identifying the differences between these two groups, and clarifying the fact that such differences exist. Microcredit experiences have brought to light the fact that the poorest of the poor are in a bad position to benefit from credit programs. It seems that they benefit more from subsidized wage programs and infrastructure improvement programs. This is valuable information for those who wish to reach the poorest members of society. Microcredit programs have also shown that the moderately poor are capable of helping themselves out of poverty given the infusion of relatively small amounts of capital. Again this is valuable information. The apparent divisions based on mathematical ability can also be put to use in the formulation of new assistance programs.

The microcredit movement is part of a learning curve on the causes and remedies of poverty. To answer the questions posed in the conclusion of section III., microcredit does seem to have a mildly positive net benefit. It has helped some families out of poverty and increased the store of knowledge as to what poverty is and how it operates. It has also given some insights into what not to do when trying to relieve poverty. These are all valuable contributions. But the hype surrounding microcredit is unwarranted. It will probably not be a major factor in the overall reduction of world poverty.

Bibliography

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Internet Resources

17. Jolis, Alan; (5 May 1996); “The Good Banker”; The Independent;
http://gdrc.org/icm/grameen-goodbanker.html

18. Khandker, Shahidur R.; (1998); “Fighting Poverty with Microcredit: Experience In Bangladesh”; Published for the World Bank by Oxford University Press;
http://www-wds.worldbank.org/cgi-bin/cqcgi/@production.env?CQ_SESSION_KEY

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