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From Small Things

Chances are that you are familiar with the names Bono, Bob Geldof and Jeffrey Sachs. Big personalities with big ideas for aiding the world’s poorest people are hard to overlook. The Norwegian Nobel Committee often recognizes visionaries with ambitious, expensive remedies for the world’s ills (e.g. George Marshall and his eponymous aid plan to Europe following World War II), even when the remedies are purely symbolic (Yasser Arafat, Shimon Peres and Yitzhak Rabin shared the Peace Prize in 1994 for their efforts to create peace in the Middle East).

While rock stars and authors use the limelight to censure rich countries for not spending tens of billions more on aid to the world’s poorest, a man, his company and a tiny idea toil largely unnoticed in the background. You may not have heard of economist Muhammad Yunus, or his microcredit company, the Grameen Bank, because their client-focused, bottom-up approach to helping the world’s neediest is modest, tedious and promises nothing extraordinary. The receipt of the 2006 Nobel Peace Prize by Yunus and Grameen hopefully marks the turning point in the way rich countries try to help billions of the world’s poorest citizens, and offers a lesson for those wishing to do good at home as well. The Prize is a nod to people who ask the question, “What causes prosperity?” and a disavowal of those who ask the question, “What causes poverty?” Nothing causes poverty, as it is the natural state of human-kind. It makes little sense to question its causes. If you do nothing, you are poor. If you are prevented from doing something, you are poor. Yunus and the Grameen Bank are looking for ways to make people prosperous by helping them become more productive. Typical development programs miss this key point by focusing on simple and hasty answers to long-standing problems.

The Failure of Development Assistance

Starting with President Truman’s Point Four program in 1949, over $2.3 trillion of development assistance has flowed from the West to kick-start the development of the world’s poorest countries. Yet nearly 60 years later over one billion people in the world remain as poor as or poorer than people before the Industrial Revolution began. Rockers and writers would have us believe that if we only spent more money, the problem of poverty could be licked. Couched in terms of malaria medicines costing only 12 cents or bed nets costing four dollars, their pleas have special allure. After all, what Americans could not afford to send a check to cover these costs?

Blaming the lack of global development on funding is like targeting the New York Yankees’ small payroll for their missing the World Series. Bureaucrats in Washington and Brussels have spent plenty of money – a recent study of USAID’s malaria control spending showed that 90 percent of its money went toward consultants and technical advice instead of life-saving nets, drugs and insecticides. What they do not have is the requisite information about how to meet the diverse needs of the world’s poorest people, nor do they have the incentives to ensure that those needs are met. Couple these economic problems with the weak formal institutions in developing countries (e.g. property rights are notoriously insecure) and the conflicting goals of the rich countries who use foreign aid programs to employ their own workers and sell their own goods (e.g. USAID purchases condoms for its AIDS prevention and family planning programs from American companies in Alabama who won federal contracts to provide them at over twice the cost of its competitors) and it is not surprising that grandiose, top-down plans have failed to deliver on their promises to lift billions out of poverty.

Sweating the Small Stuff

As a Chittagong University economics professor in Bangladesh , Muhammad Yunus and a team of graduate students went directly into the poor neighboring village of Jobra and determined that a large obstacle to progress for the poor was lack of access to credit. In 1976 he loaned 27 dollars to a group of 42 villagers and found them to be credit-worthy. Traditional credit institutions are unwilling to make loans to the very poor because they lack collateral to back the loans, or for those that own property, much of it is not recognized by the state. Informal credit mechanisms (i.e. loan sharks) routinely charge upward of 200 percent per year in interest.

Formally chartered in 1983 with start-up funds from the government, but now 94 percent owned by its borrowers, Grameen is based on a simple idea – lend very small amounts to poor entrepreneurs (Grameen states that its average loan is less than 200 dollars, though its financial statements indicate the amount is much larger). Having access to affordable credit allows small entrepreneurs to invest in grocery shops, raising livestock, weaving dresses, etc. to produce beyond a subsistence level, and through further specialization and trade lift themselves out of extreme poverty.

Grameen Bank pays attention to details. For example, Yunus recognized that while the poor had no physical capital to post as collateral they had an enormous amount of “social capital” just as important to protect. Therefore, loans are awarded to groups of five, each guaranteeing the loans of the others – whereby the threat of ostracism and other informal sanctions ensure disciplined repayment. 97 percent of loans are made to women because Yunus understood the typical discrimination against women in families and the role of women under the Purdah system – a conservative Islamic culture that restricts a woman’s personal, social and economic activities outside her home. Each group member undergoes a two-week training session to learn bank procedures, group savings programs, how to sign their name, and are encouraged to adhere to the bank’s 16 principles which emphasize modern values. An example of these principles, called “Decisions,” is #9 – We shall build and use pit-latrines; or #13 – We shall collectively undertake bigger investments for higher incomes. In short, Grameen overcomes the information problems endemic to one-size-fits-all aid programs by understanding village traditions and cultures in all of the areas in which it operates. Most of the Grameen staff come from the villages and have participated in its programs; most of its borrowers own the bank’s stock; and its board of directors is representative of its client base.

Limited research indicates that the bank has had modest success (by utopian standards). It is estimated that average household income of bank members is 25 percent higher than similar non-member households from the same village. 20 percent of bank members now live below the poverty line as compared with 56 percent of non-members. The loan repayment rate is reported to be 97 percent, though the exact rate is disputed (for comparison, the current default rate on American education loans is five percent, down from a peak of 22 percent in 1992). While these results might simply reflect selective provision of loans on the bank’s part, that Grameen has survived for a quarter century by serving poor clientele and has turned a profit in all but three years suggests that it is doing something right.

Economics Nobel Laureate Robert Lucas has concluded that no nation has ever arisen from poverty through the redistribution of wealth. But rockers’ and writers’ pleas for debt forgiveness and increased aid only serve to entrench corrupt poor country leaders and inhibit needed institutional reform while vilifying those that see the poor as a commercial opportunity. The Grameen Bank alternative that treats the poor as clients rather than charity cases helps it overcome the incentive problems endemic in top-down programs.

Its success derives from it having a focused, targeted goal with measurable outcomes (provide loans to enable the extreme poor to exercise their unutilized or under-utilized skills with loan repayment and reapplication as measures of success). It gets feedback from the poor it is trying to help (the bank goes to the villages, it does not require villagers to find them, customizing loan programs to meet diverse needs). If expectations are not met, Grameen employees and stockholders suffer (particularly since stockholders cannot sell or trade their stock). Finally, it recognizes that poverty is not a technical engineering problem that can be solved with the right ingredients and formulas. It is well aware that the causes of prosperity’s elusiveness are complex and tangled and therefore does not dictate what its clients do with the loans- only that they pay the money back – and the best way for them to do that is to do something productive. Grameen sees itself not as a solution to the poverty problem, but as a catalyst in the overall socio-economic conditions of the poor.

Just as the Industrial Revolution was fueled by entrepreneurs serving the needs of a large, poor European population (for example, Josiah Wedgewood revolutionized the production and sale of pottery in the eighteenth century and became successful by serving the needs of the poor, not the entrenched aristocracy of the time), a Development Revolution will only occur when social entrepreneurs like Muhammad Yunus are encouraged and motivated to meet the needs of those who have little money to attract the interest of traditional businesses.

The Next Fad

Microcredit is not a new idea in development – Jonathan Swift founded the Irish Loan Funds in the early eighteenth century. But their popularity has only advanced in the last decade with a seven-fold explosion of innovative finance and credit agencies (now over 3,100 exist worldwide) ranging from BASIX in India – which offers banking services in manned phone booths to Unibanka in Latvia – which uses a credit-scoring system based on qualitative client data to reduce costs of review and administration as well as to assign appropriate risks to perspective recipients. Having reached an estimated 450 million people, microfinance has the air of becoming the “next big thing” in development circles.

Economic history has taught us that it would be a mistake to throw a disproportionate amount of resources into microcredit enterprises because the same factors which stifle progress are those that are responsible for the poor’s lack of access to credit. Rich and poor country governments alike need to understand that poverty is a complex problem. The best way to fight poverty is to eliminate barriers that currently hold back private enterprise among the poor. Microcredit is neither necessary nor sufficient to fight poverty, but rather is an example of an approach that does not promise too much and has a focus primarily on reaching the poor. Grand plans do neither.

Even perfectly designed microcredit programs can fail. Grameen may provide opportunities for people to open businesses, but it has little control over whether poor country citizens have an incentive to invest in their futures. Creating these incentives requires poor countries to reduce excessive regulation (e.g. in Niger, companies are required to give all employees six weeks and two days of paid vacation per year), to restore confidence in their currencies (market exchange systems break down under high inflation), and to promote the rule of law (which includes recognition of property rights, eliminates corruption and thievery, and enforces contracts). The complexity and diversity of cultures in the developing world means these institutional reforms cannot be applied uniformly from abroad, but must be nurtured by honest people from within. Thus, microcredit and other similar projects should be privately financed by people putting their own money at stake, rather than governments and bureaucracies absorbed with applying cast solutions throughout the world.

Though Americans vastly overestimate how much money its government spends on foreign aid (a recent survey indicated that Americans believe 24 percent of GDP is spent on development assistance – over 100 times larger than the actual 0.22 percent spent in 2005), at 27.5 billion dollars the U.S. still spends more than twice as much as the next most generous country (Japan) and nearly as much as England, France and Germany combined . At the G8 Summit in Scotland (2005), rich countries each pledged to increase aid to 0.7 percent of GDP – about 630 dollars for every employed American. Given the failure of previous foreign aid expenditures, Americans are right to be skeptical that this money will be wasted.

The American tax code is unfriendly to those trying to find creative ways of helping the poor abroad or at home – and penalizes those that try to see the poor as a profit opportunity. Income tax deductions are only available if you contribute to a charity that follows all of the restrictions of a non-profit – putting entrepreneurial charities at a serious funding disadvantage. Government projects and even private philanthropic capital may create problems for entrepreneurial charities by keeping unsustainable programs alive and also by filling areas that otherwise might have been filled by organizations like Grameen.

Let the Peace Prize be a reminder to Americans that are concerned with the poor at home and abroad that governments, rockers and writers do not have a monopoly on good intentions. Let not their high sounding rhetoric convince you that they have the answers to interminable problems. Let it also serve to remind us that efforts to alleviate poverty at home and abroad are saddled with the political need to see results quickly. Massive poverty in the Western hemisphere took centuries to eradicate and if programs like Grameen are successful in making a mother into an entrepreneur, she will hardly ever have the chance to ascend into the middle and upper-classes herself; but by providing for healthier, more well-educated children, subsequent generations will certainly have those opportunities. Slow progress is better than no progress.

The recognition of Yunus and Grameen may reduce the aversion to engaging the poor in commerce. By being entrepreneurial, you can contribute to the economic growth that has lifted millions of people out of poverty since the industrial revolution, why would we want to deprive today’s poor the same opportunities?

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