Microfinance

Confronting Microfinance Myths and Legends in the Western Balkans

By Milford Bateman

Beginning with the pioneering work of Dr Muhammad Yunus in 1970s Bangladesh, the concept of microfinance (more accurately ‘microcredit’) very soon captured the hearts and minds of a generation. Microfinance seemed such a blindingly obvious idea: provide tiny microloans to the poor and you will allow them to establish or expand a very simple income-generating activity, with the additional income that they would thenceforth earn helping them to escape poverty. The heady rhetoric put forward by Dr Yunus along these lines was more than enough to get the international development community to stand up and take notice. By the 1990s, microfinance had become the most popular anti-poverty program of all.

milford bateman

Milford Bateman - Author of Why Microfinance doesn't Work ?

Importantly, the spread of microfinance was usefully consolidated by a steadily growing number of impact evaluations undertaken by the microfinance institutions themselves and by their supporters in the international development community, all of which, inevitably, appeared to confirm that microfinance was indeed having an amazing effect upon the poor and poor communities. It also greatly helped to sell microfinance to the general public when its cause began to be taken up by a raft of influential individuals – Hollywood stars, CEOs, Western European and Middle Eastern Royalty, major sports personalities, high-profile politicians (notably Bill and Hilary Clinton) and self-styled ‘trouble-shooting’ economists, such as Jeffrey Sachs and Hernando de Soto.

However, thirty years into the microfinance movement and it is now becoming quite clear that the seductive vision elaborated so skilfully by Dr Yunus and others has turned out to be nothing more than a mirage. The evidence for this is now all around us and it is overwhelming, even to long-standing supporters of the microfinance model. And even though many microfinance supporters and institutions are desperately finding new goals for microfinance to address – notably ‘universal financial inclusion’ – or else have begun to stress the importance of other aspects of microfinance rather than just the original core idea of microcredit (e.g., micro-savings, micro-insurance, micro-leasing), it is perfectly clear that a major paradigm shift in development policy is well underway – that is, the original narrow Grameen Bank concept of ‘microcredit’ is now effectively dead in the water.

Consider first the problems that have arisen in Bangladesh, the ‘spiritual home’ of microfinance. We can do no better than to reflect upon its economic and social impact in the location it was first introduced in the late 1970s and thereafter rapidly proliferated; in and around the famed village of Jobra near Chittagong. If Yunus is to be believed, then here more than anywhere else in Bangladesh we should expect to see major poverty reduction gains registered this last thirty years. But, it is not like that at all. Instead, endemic poverty and deprivation still very much persist in Jobra today.

Put simply, local demand for the simple items and services produced using a microloan does not automatically elastically stretch to ensure that everyone starting a new microenterprise will also find enough customers to earn an income and survive. Just because one basket-maker can find enough local buyers for her product and so survive, this does not mean that everyone else who then chooses to make baskets will enjoy the same outcome. Economists call this basic error the ‘fallacy of composition’, and it is this that Dr Yunus fundamentally misunderstood when formulating his plans for microfinance.

The generally finite level of local demand means that the constant new entry of ‘poverty-push’ microenterprises generally reduces the margins, wages and profits of all market participants, thanks to generally lower turnover per microenterprise. Local prices for microenterprise outputs are also depressed because of the additional (but largely unnecessary) local supply. These factors are, of course, why most existing microenterprises when asked about what would help them in their micro-business, all too often reply ‘very much less competition’.

The typical snapshot of village life is that of many traders and retailers sat alongside each other waiting for hours on end for the few customers able to buy their wares. Local demand constraints are also one of the reasons why a very high percentage of new microenterprises in Jobra, and right across Bangladesh, quickly fail – they simply can’t find any customers (at least at a price commensurate with basic survival). Micro-business failure is very important to consider because it all too often plunges the hapless micro-entrepreneur into irretrievable poverty and deprivation.

This is especially the case if they have had to sell their land or housing in order to repay the microloan, as is very often expected of them. Finally, there is now a serious new social problem to deal with in Jobra – personal over-indebtedness. In the last few years the increasingly commercialised Grameen Bank and its competitors have taken to hard-selling microloans in order to build and maintain market share and profitability, and as a direct result far too many poor individuals have wound up in possession of a bundle of unrepayable microloans.

Crucially, Bangladesh as a whole stands out as having been almost entirely left behind by its rapidly growing East Asian ‘tiger’ economy neighbours. This is not a coincidence, but a result of policy choice. By and large, the successful ‘tiger’ economies all opted to deploy a pro-active, subsidised, policy-based but nevertheless well-managed local financial model radically different to the Grameen Bank microfinance model that today dominates in Bangladesh.

Simplifying, the heterodox East Asian local financial model is marked out by the provision of affordable financial support for scaled-up formal sector small businesses and family farms that can efficiently link up with other sectors of the economy (i.e., with state companies, large private businesses, marketing cooperatives). Consider just the experience of Vietnam. It is well known that in the 1990s Vietnamese government officials checked out the Grameen Bank with a view to replicating it in their own country. But they came home disenchanted, and decided instead to establish the Grameen Bank model’s mirror opposite. Thank goodness they made this choice, one might say, because in less than twenty years Vietnam’s heterodox local financial system has played an important role in helping propel the country out of abject poverty and into near middle income status.

Turning to the very many developing countries, regions and localities that have also deployed the Grameen Bank microfinance model, they appear to have fared no better than Bangladesh. Effectively diverting their scarce financial resources into the tiniest of informal microenterprises, these countries have generally seen little economic or social benefit over the longer term and, indeed, most eventually ended up having to deal with a destructive sub-prime-style ‘microfinance meltdown’ scenario. Bolivia, Mexico, Cambodia, Nicaragua, Morocco and, most stunning of all, the Indian state of Andhra Pradesh in late 2010, all are now viewed as examples of how microfinance can seriously destabilise and undermine the local economic and social structures of most benefit to the poor, not strengthen them.

Are the Western Balkans countries any different?

The Western Balkans is one of the regions where microfinance was most brought to bear under the pressure of the international development community. In the aftermath of the collapse of the former Yugoslavia and the vicious civil war that ensued, microfinance was seen by the international development community to be one of the main recovery policies. It would supposedly address the region’s most pressing issues – poverty, inequality, exclusion and rising unemployment. Much was expected of it, especially in seriously devastated Bosnia. Many programs got started using large amounts of international reconstruction aid. Very soon the main international development agencies and key individuals were touting the apparent initial progress as indicative of a major boost to recovery and reconstruction.

However, from the vantage point of more than fifteen years of experience on the ground, our new book out in September with Kumarian Press – ‘Confronting Microfinance: Undermining Sustainable Development’ offers a very sobering estimation of the ultimate sustainable impact of microfinance. Put together by an almost uniquely experienced group of academic economists, enterprise development advisors, policy consultants, and high-level government officials (including several previous government Ministers), the general message that emerges from the book is that the hype and PR surrounding the microfinance model in the region simply does not reflect the reality on the ground. Going further, the accusation is raised that the microfinance model has actually been a major contributory factor in what is now increasingly accepted as a failed recovery in the region.

The book outlines the most pressing problems directly or indirectly precipitated by the microfinance model since 1995. Some contributors see the overarching problem to be the channelling of financial support to the very simplest of microenterprises, a trajectory that has manifestly accelerated the primitivisation, deindustrialisation and informalisation of the average local economy. In many of Serbia’s regions, for instance, a growing number of local communities are swiftly losing all touch with the formal sector, and are becoming resigned to a future of informal, non-tax-paying microenterprises servicing what little local demand exists. In Bosnia, the formal sector has also been ‘crowded out’ by this new microfinance-induced informalisation trajectory, especially the small-scale industry and industrial services sectors that history shows often provides the most number of sustainable and well-paying local jobs.

Another theme touched upon by virtually all of the chapters is the huge opportunity cost represented by the lack of funding for the crucial SME sector. Virtually all of the chapter contributors were at pains to emphasise that their respective SME sectors have been disadvantaged because of the effective diversion of scarce funds (savings and remittances) into the least productive informal sector, and so away from potentially more productive  – and desperately needed – formal small and medium businesses. The authors all argue that such a process of financial intermediation cannot be an efficient economic development trajectory for society, no matter how profitable it is for the individual financial institutions directly involved.

In fact, it took the global financial crisis to finally shake governments and the international development community into urgently providing major new programs of financial support for the SME sector. For profit-maximisation reasons, of course, the private commercial banks were simply unwilling to engage with the risky and low return SME sector, much preferring the high and relatively risk-free profits to be made by hugely upping the supply of microloans to poor households. Indeed, a noted feature brought out by several of the chapters is that the commercial banks have not been lending to enterprises of any size, but have jumped into providing simple consumption loans to households right across the Western Balkans.

The result is that many local communities have been artificially pumped up with consumer demand fuelled by such household microloans, but only for things to fall apart later on when these household microloans were retired, called in or defaulted on. A great many towns across the region are now pockmarked with only recently renovated but now hastily abandoned stores and warehouses, a testament to the temporary uptick in local consumer demand facilitated by simple household microloans, but at the cost of wasted resources into the longer term.

In agriculture, several chapters outline why only the most primitive and least sustainable agricultural operations have been supported, leaving the much more efficient family farms and agricultural cooperative structures to go without any serious form of affordable financial support. The Croatia case illustrates this problem well. Several of the microfinance institutions entered into providing support for the proliferation of ‘two-cow farms’, thinking that they were doing some good in a particularly hard-hit post-war region. But this was entirely the wrong sort of support for a recovering dairy industry, and it resulted in nothing more than a wasteful process of entry and exit, and it also depressed raw milk prices thanks to the inevitable local over-supply.

Several of the chapters, including a special chapter on gender and microfinance, went on to deal with the widely celebrated issue of gender empowerment. While the websites of the main microfinance institutions typically display their own ‘role models’ of success, the conclusion reached is that real  evidence of ‘gender empowerment’ is simply not there. Indeed, with one of the most high-profile gender-driven microfinance institutions – Žene za Žene (Women for Women) – now having to cope with a flood of delinquent women clients, the conclusion is that the wisdom (not to say morality) of blithely encouraging poor women to supply petty items and services to already vastly over-supplied local markets needs to be very strongly challenged.

Finally, the book also touches upon the impact of the global financial crisis. We find very similar sub-prime style misadventures in several countries. However, thanks to its uniquely damaging microfinance ‘boom to bust’, it is the people and government of Bosnia that have by far the most daunting set of microfinance-related problems to first overcome before they can get their economy and society on to a road leading to sustainable economic and social development.

All told, ‘Confronting Microfinance’ argues that the microfinance model has probably been one of the most damaging of the many neoliberal economic and social policies to have been implemented in the Western Balkans after 1995. These largely negative experiences therefore resonate with what is being uncovered in almost all of the developing countries in recent years, as I noted earlier, which is that microfinance simply doesn’t work.


Milford Bateman is the editor of ‘Confronting Microfinance: Undermining Sustainable Development’ which comes out with Kumarian Press in September 2012.

He is also the author of ‘Why Doesn’t Microfinance Work? The Destructive Rise of Local Neoliberalism’ that was released by Zed Books in 2010. Dr Bateman is a freelance consultant on local economic development and also, since 2005, A Visiting Professor of Economics at Juraj Dobrila University at Pula, Croatia.

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