Op-Ed: Microeffect of Microfinance

A recent article in the New Yorker echoed sentiments expressed by many venture capitalists that have begun to shift their focus on the developing world and BoP markets that microfinance, while an amazing concept for enable entrepreneurs, cannot in itself lift countries out of poverty. James Surowiecki writes:

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 … [I]t’s also because most microbusinesses aren’t looking to take on more workers. The vast majority have only one paid employee: the owner.

I agree with this opinion, particularly because I think that the current obsession with the ‘globalizationally’ sexy structure of microfinance tends to ignore the need for the creation of domestic consumption demand in struggling nations to jumpstart development.

This concern was echoed by Alan Patricoff, founder and managing partner of the venture capital firm Greycroft Partners, LLC, when he spoke at the Stern Global Business Conference last month. He summarized by saying that microfinance on its own was not the answer to development, as it failed to address the need for building small and medium size enterprises (SMEs) the true driver of job creation and subsequently development.

I am reminded of Henry Ford (prejudicial opinions ignored) who recognized the need to create a system where he paid above market wages to his employees to ensure that they could afford to purchase their own Model T’s. Ford recognized that for the most part, independent business owners are rare and that most people in capitalistic societies work for someone else, and for him to ensure that his commodities will be purchased he needed to create his own demand.

Proponents of the systemic potential of microfinance retort that the world would be a better place if everyone was their own boss. Something that the current poster child for microfinance, Muhammad Yunus has echoed. However, this simply ignores the obvious — most people are not for a variety of reasons successful entrepreneurs or even more do not have the desire to be one. But, people do want to work even if it means having someone else being their boss.

The article recognizes the dearth of such businesses that actually provide a scalable opportunity for job creation:

They need more small-to-medium-sized enterprises, the kind that are bigger than a fruit stand but smaller than a Fortune 1000 corporation. In high-income countries, these companies create more than sixty per cent of all jobs, but in the developing world they’re relatively rare, thanks to a lack of institutions able to provide them with the capital they need.

Patricoff spoke to the development of such institutions that fostered a true entrepreneurial culture. Not one based on microloans and peer to peer lending, but one focused on infusing equity investments into companies that could become the next Wipro or Reliance. Steps have been taken to bridge the gap, one of which we reported on earlier regarding Google’s (with Omidyar Network and Soros Economic Development Foundation) SME fund in India, but until major figures in the investing industry call for this, true development will not occur.