Micro-financing (also known as micro-credit or micro-loaning) is a system through which disadvantaged individuals in developing countries with an interest in starting a small business are supplied with a small loan by a micro-finance institution (MFI) . The logic holds that if enough small businesses spring up in poor communities, these businesses will generate job growth and a demand for government investment into infrastructure. In the long run, this will create sustainable economic growth and pull large segments of a given population out of poverty.
However, as with most ‘perfect’ solutions, problems arise when micro-financing is put into practice. Two notable economists who take issue with micro-financing are Milford Bateman and Ha-Joon Chang. In a paper titled “Microfinance and the Illusion of Development: From Hubris to Nemesis in Thirty Years” the authors outline several grievances they have with the practice. One is the issue of scale economies. The theory holds that a firm producing below a minimum efficient scale cannot survive in a competitive business environment, due to the inherent cost reductions that come with high levels of production. It is therefore, by their logic, statistically unlikely that micro-businesses will grow into substantial operations.
Another, less technical criticism is the fact that not everyone can succeed in the world of business. Businesses fail all of the time, and for impoverished individuals, the costs associated with a failed ‘micro-business’ are devastating. From this perspective, it is clear how micro-financing can in fact make an individual’s plight worse. Adding debt on top of an already desperate financial situation has the potential to destroy lives.
But does this mean micro-financing can never work? Arguably, the answer is no.
Another micro-financing success story comes from Somalia, where private sector development programs from the UNDP seek to help impoverished Somalis. A unique way in which the UNDP is using micro-financing in several regions of Somalia - including Puntland and Somaliland - is by supporting the review of relevant trade law to stimulate private sector growth. Updating the legal framework that deals with investment, taxation and property ownership is the first step in developing the infrastructure needed for extensive micro-financing operations. Apart from developing business, the introduction of this kind of infrastructure fosters the accessibility of poor and low-income people to financial services such as loans, savings and insurance. This is an excellent example of how micro-financing can improve the overall condition of a community.
Various accounts of the success of micro-financing does not prove the practice infallible, nor is that what this article seeks to prove. The criticism levied against micro-financing from the likes of Ha-Joon Chang is in some cases justified, but it is no reason to discount an entire method of poverty alleviation. The degree to which micro-financing benefits the world’s poorest depends on a large quantity of variables, from the responsibility and intentions of the specific MFI to the abilities and business know-how of the individual. Not every business funded by MFIs will succeed, just as not every start-up business in developed countries succeeds. If we judge micro-financing as the ‘miracle’ solution to poverty, it will never live up to our expectations. However, if we look at it as one of many tools to help those in need we may be able to replicate the success stories we see in the Horn of Africa, elsewhere.