Infernal Ramblings
A Malaysian Perspective on Politics, Society and Economics

Microcredit Works

Written by johnleemk on 5:22:22 pm Apr 18, 2007.

Microcredit is a controversial economic concept. The idea of lending people tiny amounts of capital, often only a few US dollars, originated with the Bangladeshi economist Muhammad Yunus.

The advantages of microcredit over traditional forms of aid to developing countries and impoverished communities are quite obvious. For one, it forces people to take responsibility. Yunus' pioneering Grameen Bank enforced tough interest rates, far greater than the normal rate, and refused to lend again to defaulters. The result? A repayment rate of about 97%, and with many substantially empowered families and households.

Because the money given is not free, the understanding is that it must be repaid — and since this is with interest, the only way to repay it is through some form of enterprise. Microcredit involves real loans to real businessmen and women (actually they are more likely to be women; Grameen Bank lends almost entirely to women), and yield real returns.

Unlike normal forms of charity, microcredit is not a gift. When Western donors, impressed by Yunus' work, sent him gifts of money, he opened an account for them with the bank, showing his seriousness about the business nature of microcredit.

The power of microcredit, of course, is in the incentive it provides for people to buck up and create some real value, rather than either bumming around or working for others. When you take away the strict measures that Yunus' Grameen Bank enforced which made it so successful, the lack of incentives make microcredit no better than any other aid programme, except maybe it is not subject to the same stifling bureaucracy and red tape.

One of the most potent criticisms of microcredit is that it glamorises minor things, such as aiding small-time entrepreneurs, at the cost of greater, big picture issues. Microcredit will not get roads or hospitals built, but these infrastructural items are critical to progress.

The economic empowerment that microcredit brings can be looked at from an economic perspective, however. When people are not living hand to mouth — when they are earning money for themselves — they will do two things.

The first is consume more; they can afford a new house, more food, more medicine, and the like. The second is to save more; now that they do not have to spend all their income, they can afford to save up for a rainy day or for future consumption. Some microcredit programmes, such as that of the Grameen Bank's, actually make saving a certain amount compulsory for all debtors.

Economically speaking, what is the result? The increased consumption increases the aggregate demand for goods and services in the economy, causing an increase in economic growth. The increased savings may take a bite out of this increase in the short run, but actually aid it substantially in the long run, because these savings are converted into new investment by other entrepreneurs taking loans. This new investment further boosts the economy.

But what does this matter to the question of infrastructure? Looking at it from a macro point of view, I believe that the increased aggregate demand will lead to a demand for infrastructure. When people need a hospital, and have the money to pay for it, some enterprising chap will come along and build one. The same goes for schools.

Of course this sort of large impact will not occur just yet, because it takes time for people to build up such a substantial amount of income, especially in the poverty-ridden countries where microcredit reigns, such as Bangladesh.

But over time, the newly empowered entrepreneurs will reinvest their profits, perhaps taking an extra microloan, and continue to build their businesses. And over time, they will continue to raise their standard of living — with the increases coming at an increasing rate, thanks to the simple fact that wealth begets wealth.

Does this mean that aid for building infrastructure is worthless? Of course not. But it should not be used to supplant the effects of microcredit. Microcredit creates an incentive for people to break the cycle of poverty, and utilise their entrepreneurial spirit to create value for themselves and society. This can only be beneficial for all in the long run.

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Infernal Ramblings is a Malaysian website focusing on current events and sociopolitical issues. Its articles run the gamut from economics to society to education.

Infernal Ramblings is run by John Lee. For more, see the About section. If you have any questions or comments, do drop him a line.

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