When Microfinance Fails

Question: Do microfinance loans work in Rwanda and other developing African countries?

Josh Ruxin: So micro finance for the last decade and a half or so has really been held as the panacea for the poor. And the fact is that, especially in areas like Southeast Asia, in particular, micro finance has helped hundreds of millions of people climb out of poverty.  They have not necessarily gone from poverty to wealth, not from poverty to true prosperity, but they certainly have gotten out of the most abject sides of poverty. 

Now one of the dirty little secrets behind micro finance is that the loans are actually quite expensive.  The average rate globally is about 35 to 40 percent. And I don’t know about you, but I would have a very hard time coming up with a business plan that could deliver 35 to 40 percent return on investment today and that’s one of the reasons why I have been critical of micro finance. 

It’s not that it’s a bad idea.  It’s simply that we expect a lot of some of the poorest people on the planet, in terms of the return on the investment that is placed on them. 

And one of the things that is most missing is really the opportunity to help them grow as entrepreneurs and invest in their ability to learn management and their ability to run businesses.  In my mind, one of the best things we can do is not just invest in the ultra poor, but find people who are new students coming out of school with management degrees, and help them think through business plans and help them think about to execute.  And there are actually a couple of organizations out there that work on that.

Endeavor is one of the organizations working, mainly in Latin America, that works with real entrepreneurs to help them build their management expertise and their ability to market so that they create more jobs.  Now that is not micro finance.  That’s really investing in entrepreneurs; and I would really make a distinction between the two because one is an approach for helping people who might already be wealthy get wealthier, but employ a lot more people.  And another is figuring out ways to help the poorest of the poor.  I think we’ve got to do both, but we’ve got to recognize that there are certainly shortcomings that micro finance doesn’t currently address.

Question: Does Kiva represent a better approach to financing underdeveloped countries?

Josh Ruxin:  Kiva is certainly an example of an organization that has masterfully used the power of the internet to connect people who are interested in entrepreneurs and interested in micro finance, and giving them the opportunity to actually track that progress. So on that front, that’s a innovative extraordinary breakthrough. And of course the charge on that capital tends to be substantially less than the traditional micro finance institutions.  So I find it very refreshing on that front.

Now if you actually take a look at the projects the people are undertaking, they tend not to be opportunities that are going to generate dozens and dozens of jobs.  They tend to be relatively small entrepreneurial initiatives, which again, might create some employment or some additional employment for half a dozen people, but will help the immediate recipient come out of extreme poverty or move from poverty towards middle income; and sometimes what that means is they can actually invest in friend’s businesses.  They have money to pay for healthcare or to put their kids through school.

These are all social goods that are certainly necessary and warranted and demanded today and we do need to understand better how to get micro finance out to everyone who can make use of it, but we can’t point to micro finance as the ultimate solution, even with Kiva and the internet and everything else, to the problems of general underdevelopment and a general lack of business development in the poorest countries on earth.

Recorded on: August 13, 2009.

 

Though hailed as the "panacea" for the developing world, microfinance is dependent on a particular set of preconditions for its success. When regions lack these starting points, the system is only compounding the problems of the impoverished.

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