John Paul

A Note of Caution on Microfinance

With the Year of Microcredit behind us, and investments in the sector accelerating, rarely do you hear criticisms of the much lauded poverty alleviation tool. One notable exception is a recent piece by Thomas Dichter, long-time practitioner in the international development industry and author of Despite Good Intentions: Why Development Assistance to the Third World Has Failed.

He cautions that ?microcredit is an almost perfect case of a phenomenon that has come to characterize much of development assistance – a widening gap between reality and propaganda.?

Dichter argues that in the rush to scale up microfinance offerings, many newcomers to the field might actually be doing more harm than good. He points out a number of flaws with the current approach to microfinance, cautioning that there is little historical evidence for the developmental role of credit to the poor; that there has been little rigorous evaluation of the overall benefits of microfinance to a person’s quality of life; and that the poorest of the poor are by definition the ones who “need” credit the most, but can do the least with it.

?Why do we make the assumption that in the developing countries, the poor are all budding entrepreneurs; that they will use credit wisely for investment in income production, and are ready for all manner of financial services? And how can we possibly posit that credit is a “human right” without recognizing the dangers of debt??

All very valid observations. What his analysis fails to mention, however, is that microfinance can be beneficial beyond the entrepreneurial context. What we’ve found in our research is that short term loans enable consumers to purchase many of the products and services now being developed for the base of the pyramid. Examples include insurance, irrigation technologies, and solar and other cheaper, more healthy energy technologies. These products can pay for themselves over time, and can result in a net financial gain for the consumer.

Overall, Dichter doesn?t seem to be arguing that microfinance is bad, just that its benefits are highly over-rated. He states that although some anecdotal evidence suggests microfinance is beneficial, these benefits are ?considerably less than the serious long term economic changes that are claimed for the movement.?

The hype surrounding microfinance as a tool for poverty alleviation is reminiscent of the hype that surrounded information and communication technologies when their use in development projects became vogue not so long ago. Like ICTs, microfinance is not a panacea for development. It is one of many tools that, when used properly and in the correct context, can provide developmental benefits. But assuming microfinance is applicable in all situations is a recipe for failure. I think Dichter does a good job of pointing this out.