USAID’s most recent report on microfinance and microenterprise development tells an interesting story and, in my view, shows just how widely microfinance has been (and continues to be) misunderstood. While many advocate that microfinance institutions focus on people under the global “extreme poverty line”, USAID’s report implies that actually doing so is rare and even unrealistic.

Background: the myth of targeting the poorest

The international “extreme poverty line” is around the equivalent of US$1.25 per day, and around 1.4 billion people worldwide (and over half of those in sub-Saharan Africa) are estimated to live below this line (see the discussion in our international aid report).

Many seem to believe that people in this category are appropriate – even ideal – as clients. For example, see Opportunity International and Grameen Foundation stressing the need to reach the “poorest” and “most vulnerable.” Both Accion and CGAP cite the entire 3-billion-strong set of people under the US$2/day line as potential microfinance clients (upwards of 50% of this set falls below the “extreme poverty line”).

U.S. official aid seems to have taken this idea particularly far. For the past several years, USAID has been required by law to target the “very poor,” defined partly with reference to this “extreme poverty line”:

Both the Microenterprise for Self Reliance Act of 2000 (henceforth, the 2000 Act) and the MRAA mandate that at least half of all USAID funding for microenterprise development directly benefit the very poor. The 2000 Act initially defined the “very poor” as the bottom [poorest] half of those living below each country’s national poverty line … Subsequent amendments to the 2000 Act mandated a second, much more ambitious approach … the amended law created a second definition of the “very poor” — those living on less than the equivalent of $1 per day, calculated using purchasing power parity (PPP) exchange rates. The law made clear that, for any given country, the applicable definition of the very poor would be the more inclusive one.

(Note that “$1/day” may be a reference to the $1.25/day “extreme poverty line” discussed here – see note 6.)

Investigating actual poverty levels of clients

To its credit, USAID put significant effort into tracking whether it was actually meeting this goal, developing poverty assessment tools for assessing clients’ poverty levels and requiring certain grantees to use them. The results:

Among the eight microfinance institutions that applied and reported on the Poverty Assessment Tools, the average share of Funds Benefiting the Very Poor (FVP) is estimated at 28.5 percent, up from 16.3 percent in FY 2007. … For the 14 enterprise development programs that applied and reported on the Poverty Assessment Tools, average FVP is estimated at 26.0 percent, up from 20.5 percent in FY 2007 …

USAID did not come close to its target of 50% “extremely poor” clients. Furthermore, it concluded that continuing to push for this target would be unwise:

As matters stand, USAID sees no promising options for meeting the FVP target. It cannot do so by reallocating funds among its existing partners, because with the exception of one small program, none had more than 50 percent “very poor” clients. It cannot do so by shifting funds to established microenterprise organizations that are not already receiving USAID funding, because few if any such organizations are voluntarily applying the USAID-certified poverty assessment tools, and no such organization has offered solid evidence that it has more than 50 percent “very poor” clients …

Misguided target?

USAID does not conclude that microfinance/microenterprise projects should be de-emphasized (it observes that “the great majority of clients … are very poor, at least in commonly used terms”). Instead, it concludes that the idea of serving the poorest was unrealistic/inappropriate in the first place.

the overall pattern of results lend further weight to the point that USAID raised in last year’s Annual Report – that current law imposes too low a threshold for being “very poor.” This very narrow definition makes it impossible for USAID to allocate its microfinance and microenterprise funding so as to reach the legislative target of directing 50 percent of the benefits of microenterprise funding to the “very poor,” without undermining other goals emphasized in the same legislation, such as sustainability and support for broad-based economic growth.

Unfortunately, this definition of being “very poor” was adopted without any evidence that a 50 percent FVP target based on this definition could be reached. Two years of results using the poverty assessment tools strongly suggest that the target cannot be reached without inflicting undesirable side effects on sustainability and economic development. In short, USAID sees no realistic prospect of reaching the target contained in the law, and urges prompt and serious consideration of changes in the law. (Bold mine; italics in original)

I’m inclined to agree with USAID’s conclusion. I agree that people with incomes well above the “extreme poverty line” can still be very poor, certainly poor enough that I’m interested in donating to help them. So my point is not that microfinance is being carried out inappropriately, or is failing to reach the very poor.

Rather, I’m noting yet another way in which microfinance seems to have been badly misunderstood by its biggest funders and proponents. USAID, and by implication its grantees, seem to have thought that they were serving the world’s poorest – to the point of legislating it – without any data, and wrongly. It’s another debunked myth, and another sign that the funding and the stories have gotten ahead of the facts.