The effective collapse in 2008 of the US government-Wall Street-driven model of liberal capitalism is an event of major historical importance. As with the collapse of an earlier wall in 1989 – the Berlin Wall – transition to a new economic model is now required, and is indeed underway. The microfinance industry is in no less a need for radical change. This is because many of the flawed character traits that have ultimately destroyed Wall Street also lie at the heart of the increasingly commercialised microfinance industry. In a very uncomfortable parallel with the spectacular rise of Wall Street’s most hallowed institutions and individuals, now consigned to the grubby margins of business and economic history, careerism, personal greed and the related drive for profit have also blinded the microfinance industry to the fact that microfinance is ultimately destroying the goal of reducing poverty and promoting sustainable economic and social development.

An article by Milford Bateman

Microfinance emerged in the late 1980s to become the most high-profile intervention against rising poverty in developing countries. According to Grameen Bank founder, Dr Muhammad Yunus, microfinance was going to transform the lives of the poor, and he predicted that in a couple of decades poverty would be completely eliminated. In the 1990s, the growing microfinance industry began to come under the powerful influence of the World Bank and a number of high-profile US-based international NGOs. The result was that many of Wall Street’s core aims, values, and methodologies were extended into microfinance.  According to this “new wave” philosophy, microfinance could best eradicate poverty only if microfinance institutions themselves acted as commercially driven businesses.

However, the recent collapse of Wall Street’s entire value and operating system, allied to the resulting US-led global economic meltdown this has precipitated, have combined to subject the microfinance industry to serious critical scrutiny for perhaps the very first time.  The upshot is that the microfinance industry, like Wall Street itself, stands accused of perpetrating an ongoing economic and moral-ethical disaster. 

But doesn’t microfinance work?  Not really. Consider the situation in Bosnia, one of the international donor community’s supreme examples of “best practice.”  The end of the Yugoslav civil war in 1995 saw the international donor community very quickly establish a raft of lavishly financed microfinance institutions in Bosnia, including a couple of dedicated microfinance banks (e.g., Pro-Credit Bank). A little later on, Bosnia’s now foreign-owned commercial banks also discovered the impressive profitability of simple microloans. By the early 2000s, therefore, Bosnia was on a par with Bangladesh and Bolivia in being effectively saturated with microfinance. The overarching outcome of this saturation, however, has been the progressive informalization and infantilization of the Bosnian economy, now at a very advanced stage.  With the overwhelming bulk of microfinance finding its way into the informal sector and into the very tiniest and least sustainable of micro-businesses, and with SME lending progressively abandoned (especially for start-ups) because of higher risk and lower/slower profit factors, this debilitating trajectory was inevitable. Tragically, Bosnia’s not inconsiderable industrial and technological base – an institutional asset most developing countries are desperately trying to construct – was almost entirely ignored as the starting point for a new generation of relatively technology-intensive microenterprises and SMEs.  Because of high interest rates and short repayment periods, microfinance was of no use whatsoever to those many entrepreneurs considering a new venture based upon this extremely valuable knowledge and technology base. But with no other major financial alternatives, as intended, it was therefore made inevitable that almost all such far-sighted projects would be aborted. Bosnia’s industrial base was thus allowed to collapse without even a whimper.  All told, the Bosnian economy has been subject to what many Bosnians term “Africanization” (Africanizacija), meaning its programmed descent into unsustainability and likely permanent dependence upon the international donor community (or the EU).i

But surely lots of new jobs and incomes were created in Bosnia, as the microfinance institutions widely proclaim? Well, no. The microfinance industry everywhere wrongly assumes some kind of Say’s Law operates at the local level, meaning that the unending supply of the simple non-tradable goods and services that poverty-push microenterprises typically provide will automatically call forth the local demand for such items.  But real economic life is not like this. Instead, other things being equal, new microenterprises and microenterprise expansions mainly displace existing jobs and income streams in non-client microenterprises. If we cared to look further in Bosnia, we would undoubtedly find that net job and income creation thanks to microfinance has really been quite negligible.ii In addition, we must reflect upon the fact that very many of the new microfinance-supported microenterprises (the clients) collapse after a short period of time.  World Bank researchers estimated that 50% of those moving into self-employment in Bosnia between 2002 and 2003 failed within just one year of starting their venture.iii This is a very worrying development indeed. We know that failure of a microenterprise often necessitates having to repay the original microloan by liquidating family assets - family savings, apartments, family land, and so on – as well as going even further into debt. This is, of course, why failure rates appear to have increased considerably in Bosnia, but repayment rates nevertheless remain impressive. But this also means that very many of the poor individuals who end up failing in their microenterprise venture - now probably the majority – are therefore plunged into even deeper poverty and insecurity than before.

Bosnia’s microfinance sector is not, unfortunately, the only one to precipitate such debilitating local impacts.  Far from it.  Bosnia’s predicament is certainly shared by its Balkan neighbours.iv And as a recent 2003 UN report outlined,v the globalisation-driven collapse of formal sector employment everywhere (especially public sector employment) has directly resulted in most local economies becoming saturated with poverty-push informal sector microenterprises. Here too the deployment of microfinance may well turn a healthy profit for the microfinance institutions, but almost everywhere the local economy’s functioning and growth potential is being likewise destroyed.  In Bangladesh, the microfinance sector very profitably recycles a quite significant percentage of the nation’s valuable savings back into yet more rickshaws, street food sellers, rice huskers and petty traders.  At the very same time, potentially growth-oriented, but riskier, SME and larger projects fail to attract any local financial support. In Mexico, too, a new generation of aggressively commercial microfinance banks has very profitably mobilized huge amounts of local savings and commercial funding, but this largesse is also overwhelmingly recycled back into an already bursting-at-the-seams informal sector.  Many analysts in Mexico quite rightly express their fear that the accelerating “changarrization” of the economy - a reference to “changarros” or informal microenterprises – is inevitably leading Mexico back to a primitive non-industrial base, and thus back to endemic poverty.  By all accounts, many localities and regions in India, Bolivia and in many other developing countries have moved toward emulating this locally destructive scenario.

In spite of the worrying evidence that microfinance is actually part of the development problem, and not the solution, the microfinance industry has nevertheless shown little or no interest. This attitude very closely emulates Wall Street’s reaction to those raising concerns as to the eventual outcome of its greed and speculative excess.  Yet the tide cannot be held back forever. The recent case of Compartamos has helped to highlight more than ever before the potential local destructiveness, as well as moral bankruptcy, of commercialised Wall Street-style microfinance. Originating in an NGO capitalized with significant donor grant funding, Compartamos’ rapid growth since the 1990s was made possible through charging poor Mexican women annual interest rates at times approaching 120%. In an almost perfect parallel with Wall Street’s bogus claims surrounding sub-prime loans - that the commercial banks and others may have erred in extending far too many of them, but they were simply “trying to help America’s homeless poor” - the very high profits realized in Compartamos were similarly justified on the basis that “they would eventually help more Mexicans obtain microloans.”  Yet no-one from Compartamos thought to directly ask the poor Mexican women paying ultra-high interest rates if this was what they wanted done with their earnings and reinvestment opportunities forgone. No-one seems to have considered either the moral implications of expecting the very poorest women in Mexico to effectively underwrite access to microloans for others equally poor, still less to underwrite the Wall Street-style financial rewards accruing to those running Compartamos supposedly on their behalf. Moreover, the damaging “changarrization” trend underway in Mexico’s economy is seemingly of no concern to anyone in Compartamos or in the wider microfinance industry.  Just as on Wall Street and also regardless of the wider consequences, Compartamos adopted a profit-maximisation strategy largely in order to provide cover for the generous salaries and bonuses the senior staff felt they simply had to reward themselves with, particularly from around 2000 onwards.vi Such stratospheric financial rewards then very usefully allowed the lucky recipients to begin to buy into ownership of Compartamos, with an obvious eye to the real bonanza that lay ahead in the form of an IPO.  The fifty million dollar windfalls several of the key people in and around Compartamos eventually realised are classic Wall Street outcomes based, not on development impact, but on opportunism and greed. The light at the end of the “commercialised microfinance-as-poverty-reduction” tunnel is actually an oncoming train.

So, finally, what to do?  Naturally, abandoning Wall Street-style commercialized microfinance is a start. We then need to learn the real lessons of economic history. As a growing number of development economists point out – notably Cambridge University-based Ha-Joon Changvii – today’s rich developed economies, as well as the more recently wealthy East Asian “Tiger” economies, all managed to succeed in sustainably reducing poverty not with microfinance, but with a quite different set of solidarity-driven financial (and other) institutions.  Financial cooperatives, specialized development banks, special credit institutes, and social venture capital funds were the principal instruments.  Such financial institutions ensured that domestic savings and any other funds (e.g., Marshall Plan funds in post-war Europe) were carefully and efficiently recycled back into growth-oriented SMEs and larger business projects operating in potential growth sectors. This was why many East Asian countries may have started at or near the GDP level of Bangladesh in the 1970s, but they then massively outpaced Bangladesh in terms of development, growth and poverty reduction.viii This is why the most successful regional and local economies in Europe - in northern Italy, in the Basque country of northern Spain and in the former West Germany - were able to achieve hugely positive local economic development outcomes compared to just about everywhere else in post-war Europe.ix Put simply, these local financial institutions were designed to press the key “triggers” we know lie behind sustainable development and poverty reduction – the ability to reap scale and scope economies, develop and/or use new technologies, incorporate recent innovations, develop productivity-enhancing linkages (vertically and horizontally), quickly evolve efficient organizational routines and build institutional memories, and utilize high-level skills and personnel.  Moreover - and it cannot be stressed too much - all of these crucial development “triggers” overwhelmingly occur in public, private and cooperative productive enterprises, not in microenterprises.

Lets be clear: if microfinance institutions continue to (very profitably) intermediate the bulk of a country’s domestic savings and any other funds into the exact opposite of the required growth-enhancing projects that we know underpin sustainable poverty reduction – that is, into the informal sector, and so into rickshaws, street food sellers, petty traders, subsistence farms and so on - then that country, region or locality will forever remain “locked in” to a state of grinding poverty, marginalisation and under-development. Unfortunately, this is an “iron law of microfinance.”

i Bateman, Milford. “Deindustrialisation and social disintegration in Bosnia,” in Thomas Dichter and Malcolm Harper (eds), What’s Wrong with Microfinance? London: Practical Action Publishers, 2007.
ii DrezgiiÄ, Saša, Zoran PavloviiÄ and Dragoljub Stoyanov. “Using local labour market methodologies to assess the impact of ‘best practise’ microfinance programmes: the case of Bosnia and Herzegovina,” paper presented at the European Association for Comparative Economics Studies (EACES) seminar: “The Role of Microfinance in Promoting Sustainable Development in Southeast Europe.” Great Brioni Island, Croatia, July 5, 2007.
iii Demirgüç-Kunt, Asli, Leora Klapper and Georgios A. Panos. The Origins of Self-Employment. Deveuelopment Research Group, Washington DC: World Bank, February 2007.
iv Bateman, Milford. “Borderlands and microfinance: impacts of ‘local neoliberalism’” in: Michael Pugh, Neil Cooper and Mandy Turner (eds). Whose Peace? Critical Perspectives on the Political Economy of Peacebuilding. London: Palgrave MacMillan, 2008.
v UN Human Settlements Programme. The Challenge of Slums: Global report on human settlements. London: Earthscan, 2003.
vi See the contributions by Dave Richardson on the DFN website, June/July, 2007.
vii Chang, Ha-Joon. Bad Samaritans: Rich nations, poor policies and the threat to the developing world. London: Random House, 2007.
viii Chang, Ha-Joon. The East Asian Development Experience – The Miracle, the Crisis, and the Future. London: Zed Press, 2006.
ix Bateman, Milford. “Financial Co-operatives for Sustainable Local Economic and Social Development,” Small Enterprise Development. 18(1): 37–49, 2007.`1`1 

Since 1993 Dr Bateman has been one of the most active policy consultants in South East Europe, focusing on all areas of local economic development policy and programming. He has subsequently consulted for all the major international development and relief agencies, including the World Bank, EU, OECD, UNIDO, UNDP, ICRC, as well as for the UK’s bilateral aid arm, the Department for International Development (DFID), for Oxfam GB, and also directly to several central and local governments in the region. Dr Bateman has also worked extensively in the transition economies of Eastern Europe and, more recently, has been active in the Middle East. Dr Bateman speaks advanced Bosnian-Croatian-Serbian language. Currently, Dr Bateman is a freelance consultant on local economic development policy and programming and also, since November 2006, Visiting Professor of Economics at the University of Juraj Dobrila Pula, Croatia.