The New York Times ran a story on Saturday by Elisabeth Malkin, called "Problems for Microfinancing in Mexico," that illustrates the difficulties of sizing up microcredit. The article surveys the controversy over the initial public offering of shares in Compartamos, a Mexican microfinance bank, which "began as a nongovernmental organization in 1990, started by a Catholic social action group called Gente Nueva, whose inspiration was a visit by Mother Teresa to Mexico." The spectacular IPO last April raised $450 million for the company, turned the founders into multimillionaires, and generated nine-figure gains for early investors including non-profit Accion International and the World Bank's private sector lending arm, the IFC. The IPO was a Richter-9 earthquake in the microfinance world, seeding contention between those whose vision for microfinance is of a rapidly growing commercial industry reaching millions more people each year and those dismayed at businessmen making fortunes on the backs of the poor thanks to annual interest rates approaching 100%. (For facts, see Rich Rosenberg's note for CGAP, also in Spanish and Arabic. For a round-up of opinions see the State of the Microcredit Summit Campaign Report 2007.)
The Times article closes with first-hand observations of a group of Compartamos borrowers in the village of Valle de Vazquez. We learn that Silvina Martinez, unfazed by the high interest rate, is investing her credit in her restaurant. "It's my own business…You are a slave to it, but at least it's mine." Alejandra Abundez and her daughter use the credit to feed their livestock and stock their tiny store.
Readers may finish this article and wonder, "Who is right? Is this usury or private enterprise at its best?" What should decide the matter is whether Compartamos's 100%-per-annum credit is actually helping poor Mexicans -- and that is surprisingly difficult to judge. How can we or the reporter know what the lives of Ms. Martinez and Ms. Abundez would have been like without this credit? Would they have said different things out of earshot of their Compartamos loan officer? Even if we knew, how can we judge whether their experiences are representative? As any project evaluator or reporter or thoughtful person who has studied the affairs of human beings will tell you, the truth is elusive. Instinctively, the human mind seeks stories to encode what it "knows" about the world -- and so in microfinance, as in so many realms, there is combat by storytelling. BusinessWeek exposes the "Ugly Side of Microlending" in a much harder-hitting piece on Mexico while Accion tells encouraging stories of its clients.
How to make sense of it all? One tack is to view the Compartamos debate as mainly over interest rates and profits. Roughly, Grameen Bank founder and Nobel laureate Muhammad Yunus says the 20-30% charged in Bangladesh is good, but the 100% in Mexico is a sign of a microbanker that has strayed from the proper mission and culture of service to the poor. "There is no justification whatsoever to charge hundred percent," he told PBS. "Only justification is, we want to make money." But the economics of microcredit differ fundamentally between Latin America and South Asia. For one, skilled people to run the operations cost more in Latin America relative to the size of the loans the clients can handle, perhaps because of much greater economic inequality. As the article points out, Peru's Pro Mujer, on anyone's short list of efficient and socially motivated microfinance groups, charges almost as much as Compartamos. And deeper economic and political factors may raise the price of credit in Mexico. When Uzma Qureshi and I interviewed Compartamos co-founder Carlos Labarthe for our Microcredit as Business report two years ago, he pointed out that his own Citibank credit card charges 40%. Still, there must be some level of interest where credit becomes harmful, some level of profit that becomes obscene.
I've come to see that three distinct notions of development shape debates about how microfinance affects people. They are not mutually contradictory but lack of clarity about which is meant often confuses non-experts and sometimes experts too:
- Development as freedom. Nobel laureate Amartya Sen says that development is inherently about increasing freedom. High income, education, health, democracy -- all give people more control over their own lives. As microfinance guru Stuart Rutherford has eloquently shown, microcredit and other financial services give the poor options in managing their money. For Sen, that is development. But doesn't credit also trap some people in debt, restricting freedom? (Above, Silvina Martínez described herself as a slave…) I asked Rutherford that a few weeks ago in Bangladesh. He said he has looked hard for examples of the debt trap there and found almost none. Microcredit, unlike a Visa card, demands that repayment starts immediately, which helps defuse the "buy-now-pay-tomorrow" attitude that gets some card holders in trouble. And perhaps most people perpetually living close to the financial edge use credit more judiciously. Still, BusinessWeek and the controversy in Andhra Pradesh remind us that abuse can happen.
- Development as institution-building. The development of the United States over the last few centuries is a story not just of rising GDP/capita, but of the birth and growth of many institutions -- governments, corporations, non-profits -- which have transformed how people interact to produce things they value. These institutions are to various degrees accountable to other actors in society, which checks their excesses, encourages them to innovate and compete, and makes for dynamism. In this light, the mere existence of Grameen and BRAC in Bangladesh and BRI in Indonesia, employing thousands and serving millions, is development, full stop. They enrich the fabric of their societies.
- Development as measurable impact. This is the bread-and-butter of evaluators. If microfinance is radically expanding people's freedom, if those rising institutions are so great, shouldn't the benefits show up in how much clients earn and spend and how many of their children are in school? Impact is notoriously difficult to measure. I am convinced that nearly all microcredit studies to date have serious problems. A new generation of randomized trials (here, here, and here) may change the picture in the next few years. For now, the evidence is sparse.
Of course, we hope microfinance is succeeding with flying colors on development-as-impact. But for those who would learn from it, the history of foreign aid teaches humility. And the limits to human understanding of social phenomena like the provision of microfinance are more severe than many realize. The impact of outsiders' aid is rarely so dramatic as to be easily measured. In the face of such limits, we will often need to fall back on the first two definitions in judging microfinance and comparing it to other things that donors and socially minded investors could do with their money.
Falling back on the first two perspectives forces two bottom-line questions, one of fact, one of morality. Compartamos clearly scores high on institution-building. But is it increasing clients' freedom, their financial maneuvering room? Robert Cull, David McKenzie, and Christopher Woodruff found that Mexican micro-entrepreneurs earn 20–33% per month on additional capital -- 790-3000% a year! -- so borrowers may well get ahead even when paying 100%. But that is the average. Tough questions anyone judging Compartamos must ask are: What percentage of clients borrow only to see businesses fall flat, landing them in catastrophic debt trouble? And how low should that number be to make 100%/year credit a good thing overall?