New Yorker: What Microloans Miss
Excellent article on both the benefits and limitations of microloans.
... Microloans make poor borrowers better off. But, on their own, they often don’t do much to make poor countries richer.
This isn’t because microloans don’t work; it’s because of how they work. The idealized view of microfinance is that budding entrepreneurs use the loans to start and grow businesses—expanding operations, boosting inventory, and so on. The reality is more complicated. Microloans are often used to “smooth consumption”—tiding a borrower over in times of crisis. They’re also, as Karol Boudreaux and Tyler Cowen point out in a recent paper, often used for non-business expenses, such as a child’s education. It’s less common to find them used to fund major business expansions or to hire new employees. In part, this is because the loans can be very small—frequently as little as fifty or a hundred dollars—and generally come with very high interest rates, often above thirty or forty per cent. But it’s also because most microbusinesses aren’t looking to take on more workers. The vast majority have only one paid employee: the owner. As the economist Jonathan Morduch has put it, microfinance “rarely generates new jobs for others.”
This matters, because businesses that can generate jobs for others are the best hope of any country trying to put a serious dent in its poverty rate. Sustained economic growth requires companies that can make big investments—building a factory, say—and that can exploit the economies of scale that make workers more productive and, ultimately, richer. Microfinance evangelists sometimes make it sound as if, in an ideal world, everyone would own his own business. “All people are entrepreneurs,” Muhammad Yunus has said. But in any successful economy most people aren’t entrepreneurs—they make a living by working for someone else. Just fourteen per cent of Americans, for instance, are running (or trying to run) their own business. That percentage is much higher in developing countries—in Peru, it’s almost forty per cent. That’s not because Peruvians are more entrepreneurial. It’s because they don’t have other options.
What poor countries need most, then, is not more microbusinesses. They need more small-to-medium-sized enterprises, the kind that are bigger than a fruit stand but smaller than a Fortune 1000 corporation....