You Can't Have It All

A couple of weeks ago, CGD convened its Advisory Group, which we use as a rigorous sounding board as we plan our research. I presented my preliminary thinking on What We Talk about When We Talk about Development, which abstracts from the three notions of "development" in Part II of my book (chapters 6--8).One comment really stuck with me, and that was Jonathan Morduch's. He said that it's great how my listing of these notions of development has helped clarify the discussion about whether microfinance "works." But: Don't forget that there may be trade-offs between different kinds of success. Understanding these trade-offs matters for practical action.I realized that I had put so much energy into constructing this simple paradigm and applying it---judging microfinance by whether it reduces poverty, increases freedom, builds industries---that I hadn't gotten as far as looking at tensions between the different kinds of success. That inspired this draft section of the concluding chapter, which I hope to post soon in full.

Economics is sometimes defined as the study of the optimal allocation of scarce resources. In truth, there is more to economics (resources are rarely allocated optimally anyway), but the definition is fair in that dismal scientists often think in trade-offs. Changing the allocation of labor and capital—rejiggering a factory—means more toasters but fewer microwaves. Having scored microfinance against various standards, it is helpful to introduce into the analysis the idea of trade-offs. This book has labored to think clearly and gather evidence about success. But that evaluation is only input to judgment, which is necessary for making choices.The notion of trade-offs applies on at least two levels: in comparing microfinance to other charitable projects, and in comparing styles of microfinance. At the first, upper level, the notion brings us to the grand questions of this book: Does microfinance deserve all that praise and funding? Or are microfinance investors just chasing fantasies? Should they use their money in other ways? Microfinance is not unusual in the degree of our ignorance about its impacts. Fragmentary evidence from half-believable studies are the norm in charity. So it is impossible to know what the best use of funds is in any particular case. I think that financial services for the poor do deserve a place in the world’s aid portfolio, for two reasons. First, microfinance has compiled impressive achievements in building institutions that enhance the freedom of millions. These achievements come with caveats, especially about the dangers of credit, but they do not seem fatal to microfinance generally. Second, a principle of diversification applies in charitable investing just as it does in conventional investing: given these achievements, the importance of financial services in the lives of the poor, and the inevitable uncertainties about the impacts of microfinance, school-building, road-building, or anything else, it is wise to invest in several strategies at once. Within limits, diversification reduces risk.As for trade-offs within microfinance, between different styles of microfinance, debates are longstanding, though traditionally referred to in language slightly different from that I have introduced. By the late 1990s microfinance specialists debated the relative importance of serving the poorest, even if that required subsidizing interest on credit, and weaning MFIs off subsidies so that they could grow unconstrained by foreign aid budgets, thus serve far more people. Economist Jonathan Morduch called the split the “microfinance schism.” Within this breach, however, a school of thought grew up that questioned the inevitability of trade-offs—or at least submitted that business-like sustainability need not cost much in “depth of outreach” to the poorest. MFIs could sustainably serve legions of quite poor people while covering costs. True to his economics training, Morduch doubted that choices could be dodged so easily. With coauthors, for example, he demonstrated that increasing interest rates 1 percent (not 1 percentage point) in Dhaka, the capital of Bangladesh, reduced borrowing by slightly more than 1 percent on average. Within that average, poorer people cut their borrowing most. The implication: cutting interest subsidies at an MFI might make it more self-sufficient by putting credit beyond the reach of the poorest. With other coauthors, Morduch examined data on MFIs around the world, looking for relationships between profitability (negative for institutions that are not self-sufficient) and the shares of clients that are poor and/or female. While hardly uniform, the overall correlation was negative. “[I]nvestors seeking pure profits would have little interest in most of the institutions we see that are now serving poorer customers.” My own review of the evidence also hinted at trade-offs, especially between the viability of institutions and the freedom of clients. Recall the end of chapter 7: “There is a margin at which convenience for the institution and the needs of the client conflict.” MFIs can do credit more easily than savings or insurance, yet it is credit that curtails freedom. Layering services on top of financial services, such as in Indian self-help groups and the Freedom from Hunger’s melding of teaching and lending, usually takes subsidies—but my enhance women’s agency more. Higher interest rates may be good profits at individual MFIs and for the dynamism of the industry—and bring the whole business to a flirtation with “usury.” Likewise, the trade-off between development-as-industry-building and development-as-poverty-reduction is so mathematically direct as to almost escape mention: higher prices make clients poorer.If it is easy to point out tough choices, it is harder to make them. The trade-offs vary over place and time in ways we cannot gauge any more than we can predict the precise consequences of a one-percent interest rate hike on a hundred different borrowing family. Even if we knew exact consequences, moral imponderables would raise their heads: how to weigh the short-term benefits of cheap services against the long-term gains from growing, self-financing MFIs; or whether to help a small set of extremely poor families or a large set of less-poor. That, for anyone trying to help others, is life.In the face of such unknowns, I suggest two principles of action. First, don’t give up hope on dodging supposed trade-offs. The dictatorship of hard choices is only absolute if microfinance institutions are squeezing every ounce of productivity from the capital and labor they consume—only absolute if the status quo in some moral calculus is truly optimal. Such perfect firms reside only in textbooks. No real firm operates at what economists call the technological frontier. Thus the choices in microfinance today are not entirely dismal. Sometimes they advance on several fronts at once. The chief opportunity I see is in savings. Win-win gains are especially realistic for investors when they cause the inefficiency, such as when their eager finance undermines the drive to take savings. I will elaborate momentarily.The second principle of action is that microfinance (or anything else) is mostly likely to achieve its constructive potential when it follows its natural constructive tendencies. If your daughter were a piano prodigy, you would probably try to give her a balanced life and education, but not to the point of stunting her talent. But you would probably not nurture any tendencies to sociopathy: thus the emphasis on constructive. By this principle, microfinance is likely to do the most good when it plays to its strengths. Going by the review above, the microfinance project’s real talent is for building industries. Among charitable projects, it is in this respect truly prodigious. To echo the previous chapter: “There is no Grameen Bank of vaccination. One does not hear of organizations sprouting like sunflowers in the world of clean water supply, hiring thousands and serving millions, turning a profit and wooing investors.” In contrast, client-for-client, microfinance does not stand head and shoulders above other forms of aid in eliminating poverty. With respect to Morduch’s “schism,” I therefore side, though not dogmatically, with those who seek to reach the largest clientele.