Report Casts Doubt on Giving Small Loans to Poor Entrepreneurs

Global microfinance programs may not help reduce overall poverty in the developing world, new research shows.
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Despite ongoing efforts by the United Nations, microfinance programs  offering small loans to local entrepreneurs do little to reduce poverty in the developing world, a new report says.

In some cases, the programs may actually be making matters worse by encouraging borrowers to create subsistence enterprises that will never lift them out of poverty, according to Aneel Karnani, an associate professor of strategy at the University of Michigan's Ross School of Business.

Rather than offering cheap start-up capital, governments and businesses  seeking to fight global poverty should instead focus on job creation by "supporting larger enterprises in labor-intensive industries," Karnani concludes in a report published in the Stanford Social Innovation Review.

Microfinance, which has gained support from Warren Buffett, Bill Gates, and other wealthy philanthropists, is aimed at helping residents in the world's poorest nations establish their own businesses through innovative lending initiatives.

The strategy gained prominence last year when Muhammad Yunus, a Bangladeshi economist and banker who pioneered the global microfinance movement, was awarded the Nobel Peace Prize.

Grameen Bank, which Yunus founded in Dhaka, Bangladesh, in the mid 1970s, offers lines of credit as low as $9 for beggars to buy bread, candy, toys and other goods to sell on the street. It has also broken social taboos by offering small-business loans to women in Muslim countries to buy cell phones, sewing machines, and weaving materials.

Today, the bank provides loans to nearly 7 million people -- 97 percent of whom are women -- with some 2,226 local branches throughout the country. It claims a 98 percent repayment rate.

"By defining 'entrepreneur' in a broader way we can change the character of capitalism radically, and solve many of the unresolved social and economic problems within the scope of the free market," Yunus said at his Nobel Prize acceptance speech in December.

Yet, Karnani said research showed most businesses that relied on microcredit tended to take out conservative loans that directly protected their subsistence, rather than investing in new technology, fixed capital, or new jobs  -- the kind of economic activity that would spread benefits beyond small-business owners themselves.

He points to differing development patterns between Africa and China  in recent decades. In Africa, declines in job creation have raised poverty levels throughout the continent. By contrast, China has managed to reduce poverty by investing in large corporations and boosting employment, Karnani said.

"We should not romanticize the idea of the 'poor as entrepreneurs," he said, adding that not everyone is cut out to make it as a small-business owner.

"Most people do not have the skills, vision, creativity, and persistence to be entrepreneurial," he said. "Even in developed countries with high levels of education and access to financial services, about 90 percent of the labor force is employees, not entrepreneurs."

For its part, the United Nations argues that fewer employers in poorer nations means fewer jobs. As many as three billion people worldwide lack access to basic financial services -- including bank accounts, loans, and insurance, U.N. figures show. In sub-Saharan Africa alone, just 30 million out of a total population of 744 million have access to financial services.

Last month, it urged governments, regulators, and private sector lenders around the world to boost access to financial services for the poor.

"Access to a broad range of financial services is a significant development issue everywhere outside of developed countries," said Richard Weingarten, executive director of the U.N. Capital Development Fund. He said empirical evidence shows that those who participate in microfinance programs stand a better chance of improving their welfare.

The U.N. has set a target of slashing global poverty by 2015.       
 

 

Last updated: Jul 6, 2007




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