Introduction

This book is about one component of the global financial sector – microfinance – that in just thirty years has risen to become one of the most important policy and programme interventions in the international development community. As originally conceived, microfinance is the provision of tiny loans to poor individuals who establish or expand a simple income-generating activity, thereby supposedly facilitating their eventual escape from poverty. Its advocates claim that microfinance has been critical to the fate of the poor in many developing countries, creating jobs and raising incomes in the poorest communities, helping to empower the poor (especially women), and generally kick-starting a 'bottom-up' economic and social development process. The person most associated with the 'discovery' of microfinance in the 1970s is the Bangladeshi economist and 2006 Nobel Peace Prize co-recipient, Dr Muhammad Yunus. With his vision of rapid and affordable poverty reduction being achieved through microfinance, Yunus was able to convince virtually everyone in the international development community to support his efforts. Indeed, the next generation, he famously said in the 1980s, would be able to understand the concept of poverty only after having visited a 'poverty museum'. Here, surely, was the poverty reduction concept that all developing countries had been waiting for.

The central argument that I will develop in this book, however, is that microfinance is largely antagonistic to sustainable economic and social development, and so also to sustainable poverty reduction. Put simply, microfinance does not work. I fully accept that there are some minor benefits to be derived from the widespread provision of microfinance to the poor. An intervention that puts a little extra cash into the hands of the poor in any community – and especially if that cash is brought in from outside the local community in question – could hardly do otherwise. But I argue that these benefits are very minimal indeed, and anyway wholly insignificant when set alongside the huge longer-term downsides and opportunity costs inherent in the operation of the microfinance model. To focus upon these few minor shorter-term benefits is to deliberately focus on the few trees left standing after having helped the entire forest to burn down. In truth, once we go beyond the fabulous 'feel-good' PR and marketing effort undertaken on behalf of the microfinance model, no more so than by Muhammad Yunus himself, we find a completely different reality. Sustainable local economic development trajectories are actually undermined and blocked. Local communities are structurally weakened and destroyed. Important reserves of solidarity, mutuality and cooperation are trashed thanks to the internecine competition between desperate individuals 'poverty-pushed' into establishing the very simplest of microenterprises. Human dignity and self-respect are lost as the poor in developing countries are increasingly forced to accept their permanent engagement with the most primitive, illegal, dangerous and demeaning business activities imaginable. Overall, those developing countries awash with microfinance – and the prime example, of course, is Bangladesh itself – are increasingly being left behind by other developing countries, those that have proved far sighted enough to channel investment into the type of enterprises, infrastructures and institutions that, when combined, have far more potential to produce a substantive and sustainable growth and development payback. All the while the various ways in which the poor have in recent history been able to successfully escape grinding poverty and achieve tolerable living standards and opportunities – by exercising their collective capabilities through pro-poor political parties, social movements, supportive state structures, trade unions, associations, single-issue pressure groups, and the like – are now ruled to be completely off the agenda. The poor are instead increasingly thrown back on to their old, and largely unsuccessful, historical mission; to attempt vainly to rescue themselves from their own poverty and suffering solely through their own individual actions and meagre resources.

Another core argument I make in this book is that the increasing commercialization of microfinance is responsible for greatly amplifying the destructive impact registered by the basic Grameen Bank microfinance model. A central development within the world of microfinance was the schism that took place in the 1990s, when the subsidized Grameen Bank model was effectively abandoned and a completely new commercialized microfinance model – what I term the 'new wave' microfinance model – was ushered in as its replacement. From now on, a microfinance institution was to be a business, and its primary objective was to attain full financial self-sustainability and profits as quickly as possible. Even if the poor would greatly benefit from low interest rates and the additional net income that would then result from any simple income-generating project, an outcome that might in turn necessitate subsidies from the wider (richer) community, tough. Reconstituting microfinance as a for-profit business model, however, has had quite disastrous consequences. Just as on Wall Street, we now find 'new wave' microfinance increasingly defined by unethical profiteering, greed, irresponsible risk-taking, speculation and 'microcredit bubbles'. PR efforts to the contrary notwithstanding, that microfinance largely exists to promote poverty reduction is a concept that lost any traction many years ago.

The arguments made here also have considerable implications for theories of financial systems, and particularly how a financial system influences economic growth, as well as its impact upon the distinct process of sustainable economic development (where growth is based on respect for economic, social and environmental outcomes). If we accept that it is not simply the quantity of finance available which determines the rate of growth and sustainable development, but also how, where, when and in what form financial resources are deployed, then we have here a very useful case study indeed. Many developing-country financial systems have been very significantly restructured towards microfinance, with the corollary being the progressive abandonment of lending to the small and medium-sized enterprise (SME) sector. So how does a microfinance-dominated financial sector work, and is it good for growth and sustainable development? With Bangladesh, the most famous example of a financial system structured around microfinance, later joined by Bolivia, Mexico, Cambodia, Uganda, Mongolia, Bosnia, Peru, Nicaragua, and many parts of southern India, we now have important real-life country and regional examples of microfinance 'saturation' to examine. While we still await the definitive large-scale empirical work on the topic, the evidence that has emerged so far seems to suggest that the growing presence of microfinance within a local financial system has been quite destructive of sustainable development and poverty reduction objectives.

Going beyond theory, I hope this book will also, finally, help to outline important practical lessons for local communities, and why alternatives to microfinance must be urgently fashioned. Local communities in most developing countries have been under stress for far too long, with the global financial crisis beginning in late 2008 adding massively to their existing woes. I firmly believe that in conjunction with sympathetic and proactive higher government structures, poor local communities could achieve far better things than at present under microfinance. To do this we need to study and learn from the notable successes enjoyed by other local financial systems and heterodox local microfinance models. I outline in Chapter 7 a number of the most interesting examples from recent history. Of course, these examples have their problems. And replication and adaptation of policy models are never easy: historical, economic, cultural and political context can be crucial. But the many successes of post-1945 European countries and regions, and then of the East Asian 'Tiger' economies from the 1960s onwards, help to show just what an appropriately designed 'development-driven' local financial system can accomplish. It is far better that developing countries learn from and adapt these positive 'on the ground' experiences, rather than look to neoclassical economics textbooks pointing to the theoretically possible development benefits of microfinance, benefits that I argue in this book simply don't exist in practice to any meaningful extent.

Bringing reality back in

This book was largely put together as the most serious economic crisis since the 1930s was unfolding right across the globe. Now officially defined as 'The Great Recession', this latest economic crisis meted out a very severe beating to the idea that free market capitalism is the answer to the growing economic, social, cultural and environmental problems confronting humankind. To be more accurate, we have just seen the most recent and most fundamentalist variant of capitalism – neoliberalism – explode before our eyes. An ideology premised on the infallibility of self-regulated financial markets, private ownership and unrestrained individual self-interest collapsed in late 2008 just as spectacularly as the Berlin Wall and communism fell at the end of 1989. And it could even have been much worse than this – the end of the entire global capitalist system no less, according to the Financial Times – had it not been for unprecedented levels of state intervention and company rescues, subsidies to the financial sector running into the trillions of dollars, and Keynesian-inspired stimulus packages propping up consumer demand right across the globe. Even the reflexively anti-state Economist magazine had to come clean and admit that a second and even deeper Great Depression was only very narrowly avoided, thanks to the 'biggest, broadest and fastest government response in history'.

So we are – or, at least, should be – in the middle of a major episode of rewriting economic theory and policy to take into account the sheer enormity of the destruction that has just happened, and the human suffering now left in its wake. If the Great Recession has a silver lining to it, then, it will come in the shape of much greater freedom to challenge and discard the core neoliberal policies that have patently failed not just today's generation, but also future generations as well (thanks to truly astonishing levels of debt now bequeathed to them). Today, there are no more 'sacred cows' in economic policy.

Accordingly, in this book I take the opportunity to provide my own critical take on perhaps the most popular 'sacred cow' in the international development policy field – microfinance. I will show why it is not the solution to poverty and underdevelopment that we were originally led to believe it would be. In fact, I suggest that microfinance is actually a 'poverty trap', an 'anti-development policy' that ultimately destroys the potential for sustainable local economic and social development, and so also for sustainable poverty reduction.

The rise of microfinance

'I strongly believe that we can create a poverty-free world, if we want to ... In that kind of world, [the] only place you can see poverty is in the museum. When school children will be on a tour of the poverty museum, they will be horrified to see the misery and indignity of human beings. They will blame their forefathers for tolerating this inhuman condition to continue in a massive way ...' Muhammad Yunus

Largely thanks to the pioneering work of Muhammad Yunus and the Grameen Bank that he established in Bangladesh a little under thirty years ago, a new concept of small-scale finance was added to the financial lexicon: microfinance. In a short space of time, the microfinance model became the international development community's poverty reduction policy and programme of choice. The award of the 2006 Nobel Peace Prize jointly to Muhammad Yunus and to the Grameen Bank he founded in 1983, followed in August 2009 by the award of the US Presidential Medal of Freedom, are just the most high-profile in a long line of awards and glowing tributes to the individual most closely associated with microfinance. Having pioneered such an important new financial sector innovation, one that has supposedly proved to be of enormous importance to the world's poor, such personal awards and celebrity are widely seen as richly deserved.

This chapter will chart the 'discovery' of microfinance by Muhammad Yunus in 1970s Bangladesh. I will show how an idea designed to help Yunus's local village was turned into an international development policy and programme behemoth. What is so extraordinary about the Grameen Bank story is that it was based on a flawed understanding of basic economic principles (as we shall see), and initially it could offer nothing more than hope and good intentions to convince the international development community to offer its support. But it nevertheless rapidly prospered and went on to become the enormous power and influence that it is today in international development circles, if not – judging by the number of ordinary people who have rallied to its cause – in everyday life too. Moreover, it is even more extraordinary to find that in the course of three decades lifting Muhammad Yunus up almost to sainthood, the international development community actually had to insist in the meantime that he abandon almost all of the core principles upon which he had established the original Grameen Bank model! Yunus overwhelmingly remains the public 'face' of microfinance right across the globe, but the 'new wave' microfinance model that dominates today is a radically different local financial model to the one he pioneered in Bangladesh in the 1970s.

Birth of an idea

The 'discovery' of what we commonly refer to today as microfinance is by now a well-told story. It starts in Bangladesh, a country that in the 1970s was recovering from a bloody conflict associated with its independence from Pakistan in 1971. In the early 1970s, Muhammad Yunus was chairman of the Economics Faculty at Chittagong University. He obtained this position after returning from a long sojourn in the USA, where he had been first a doctoral student and then a university lecturer. Shocked at the appalling poverty and human suffering he found on his return, Yunus began to think about what might be done to improve the situation.

Immediately Yunus made himself more familiar with a number of the credit-based projects under way in the poorest communities in Bangladesh. As he set about thinking what he was going to do next, Yunus was able to draw inspiration and important lessons from these projects. Perhaps the most important of the credit-based projects under way in the early 1970s was a form of microcredit directed towards the poor. This project had been pioneered in the 1950s in East Pakistan (later to become Bangladesh) by Akhtar Hameed Khan. In Khan's 'Comilla Model', microcredit was disbursed to poor rural communities through village- and sector-based cooperatives. The basis for Khan's experiment was the urgent need for an alternative to the rich local moneylenders and traders, who were widely seen as holding back the rural poor through the usurious interest rates they charged. There were many positive aspects to the Comilla Model, such as the solidarity generated within the cooperatives, a feature that was also projected out into the community. The Comilla Model failed to flourish as much as had been hoped, however. Analysts identified several reasons for this. One was that the Pakistani government continually interfered in the project, hoping to use it as a vehicle for rebuilding local physical infrastructure. Another problem was that of 'elite capture'. This occurred when the richer and more articulate members of the cooperatives began to manipulate themselves into positions of power in order to appropriate most of the project's benefits. Still, the Comilla Model provided an obvious reference point for Yunus and the direction he was about to take.

At the same time, Yunus was struck by the creativity of the poor in his district in figuring out how to survive. This was especially so in the case of poor women. On regular visits to the nearby village of Jobra he saw that, alongside traditional farming activities on the family plot, almost all poor women were engaged in some form of tiny income-generating activity – rice-husking, raising chickens for eggs and meat, net-making, street food preparation, petty trading, and so on. Yunus immediately thought that if these poor individuals could be encouraged to expand their existing income-generating activities, or start a new line of work, their lives, and the lives of those around them, would be improved considerably.