Why Doesn’t Microcredit Create Entrepreneurs?

The authors of a new book that looks at ways to reduce poverty around the world (and whether they work) have suggested one possible reason why the microcredit model may not be creating more entrepreneurs: It rewards cautiousness. Microfinance institutions have “rigid rules” that require small loans of a pretty fixed size, a weekly cycle of repayment often starting within one week of loan issuance, and lending to groups whose members keep an eye on each other, say the authors—economists Abhijit V. Banerjee and Esther Duflo.

“There is a clear tension between the spirit of microcredit and true entrepreneurship, which is usually associated with taking risks and, no doubt, occasionally failing,” they write. “It has been argued, for example, that the American model, where bankruptcy is (or at least was) relatively easy and does not carry much of a stigma (in contrast with the European model, in particular), has a lot to do with the vitality of its entrepreneurial culture. By contrast, the MFI rules are set up not to tolerate any failure.” The book cites a study that allowed some clients to begin repaying their loans after two months, rather than after one week, and which found that those given more time made larger (and riskier) investments, such as buying a sewing machine rather than a few saris to sell.

This might appear to be more fodder for critics of the microfinance industry, which has faced a backlash in India in recent months. But Mr. Banerjee and Ms. Duflo don’t say microcredit firms are necessarily wrong to focus on inculcating strict repayment discipline or keeping loan sizes small. In fact, that may be exactly the right approach, they say, for lending in the circumstances in which they operate. Those small loans just won’t necessarily create businesses. And maybe that’s okay. The implication of this section seems to be that financing entrepreneurship and reducing lending costs for the poor are two different goals—and perhaps don’t need to be combined.

For those who see microcredit as a way to give poor households a little more flexibility in making financial decisions and to improve their lives, the industry is already accomplishing a fair bit. No one faults credit card holders, after all, for using their cards to take advantage of a great discount on a necessary purchase and save money, rather than to set up a business (as long as they pay back their debts on time).

SOURCE