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 …
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.
This is the painful truth about microfinance; and it has been true for the last 30 years. It is not the great panacea to reach the poorest of the poor that aid workers want to believe it is.
Loans can be a very efficient means of helping those that already have a reliable (but small) source of income. A loan allows a small business-owner to buy tools or machines or storage space, or to start buying supplies up-front in bulk. Temporary economic breathing room allows for permanent economic improvements.
The world’s poorest are not best helped by loans because they can’t afford to repay loans. It’s foolish to use money to buy capital to allow later repayment when you need the money to buy bread.
“It’s another debunked myth, and another sign that the funding and the stories have gotten ahead of the facts.”
It’s also another instance of using the concept of excessive suffering (under the guise of expressions like “extreme poverty”, “the very poor”) for reaching ends that are, as a matter of fact, connected to the alleviation of suffering only by wishful thinking.
In order to get rid of that kind of pervasive ambiguity which is so profoundly harmful, I suggest that there should be a whole new philanthropic sector oriented toward the direct, evidence-based, and systematic alleviation of excessive suffering, while the rest of philanthropy would continue to be concerned with the usual causes, like economic development, health, education, justice, etc.
I definitely agree Robert with what you’re saying about evidence-based philanthropy, as this is something we’ve given a lot of thought to at SeeYourImpact. While there’s a tremendous need to help the 1.4 billion people in extreme poverty, as Sarah says, micro-loans aren’t always the most appropriate solution.
While micro-donations may not have that same ‘self-starter’ appeal of micro-loans, the organizations and projects we support are doing an incredible job of giving those in extreme poverty a hand up. We also believe that the ability for donors to see the actual people benefiting from their generosity provides a great opportunity to build viral awareness for these projects!
“We also believe that the ability for donors to see the actual people benefiting from their generosity provides a great opportunity to build viral awareness for these projects!”
This is an appealing idea, Benjamin, and SeeYourImpact looks interesting, in spite of some criticisms from the GiveWell perspective that may come to mind. Perhaps you and I should talk about the question I asked at http://groups.yahoo.com/group/givewell/message/200 : “How can I stop or prevent at least one occurrence of excessive suffering?” If you feel so, you might take part in the GiveWell Yahoo group, or write to me at firstname.lastname@example.org.
I think it’s important that we also think about who is receiving these micro-loans, especially of our goal is to alleviate suffering. Most of the time it is women receiving these funds and the focus is on economic gain. This can sometimes lead to improvement in their financial situation, but many times women are still being oppressed and discriminated against. Microloan programs also need to incorporate a social justice program in order to address the issue of gender inequality.
My view of microfinance has become quite simple. A healthy financial services sector that provides appropriate, affordable services to all segments of society is very important to development. As we well know, the private sector alone will not meet this need – nonprofit organizations and governments have important roles to play in innovation for poorer market segments and risky areas like agricultural finance, capacity building, oversight, etc. If you identify with the need to build systems that societies need to function well, then find a good microfinance support organization to donate to (someone really should do a comparative analysis to figure out which ones are “good” from this point of view). If, on the other hand, you want to maximize the impact of your donation on individual lives, or a specific group of people, look elsewhere.
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