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Is Microcredit Efficient? September 9, 2007

Posted by federalist in Economic Policy, Markets.
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Microcredit has a certain libertarian allure: It imagines that everyone is a potential entrepreneur and that the only thing that stands in the way of a typical impoverished human being is access to capital. A developing country may lack the legal and physical infrastructure to support large-scale industry, but any individual with a will and a way can produce something of value and prosper by that.

The reality may be quite contrary: Not every person is capable of producing excess value on their own, or of realizing that value through trade. It may be that we really do require healthy markets, exceptional industrial leaders, and economies of scale to turn raw human capital into valuable production.

This argument is made in compelling fashion by Aneel Karnani in this month’s Worth (adapted from a longer essay available in SSI Review):

Most clients of microcredit are not entrepreneurs by choice; they would gladly accept a factory job at reasonable wages if one were offered.

… Job creation is not enough. We also have to increase productivity so that wages are high enough to enable employees to rise above poverty. One way to increase productivity is to encourage enterprises that are large enough to achieve economies of scale. Rather than lending $200 to 500 women so that each can buy a sewing machine and make garments, we would be better served by lending $100,000 to an entrepreneur with managerial capabilities and business acumen to help her set up a garment manufacturing business employing 500 people. This type of business can exploit economies of scale, deploy specialized assets and use modern business processes to generate value for both owners and employees.

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1. bwv - September 11, 2007

Many microcredit recipients do hire employees.

However attractive and more efficient larger enterprises may be in theory, a lack of legal infrastructure is a major impediment to creating larger corporate structures in most places where microcredit operates. Gaining the necessary bureaucratic approvals or even having adequate supplies of power or water can be next to impossible in these countries. Furthermore, the larger allocations of capital neccessary to create these enterprises runs the same risks of graft of older direct foreign aid programs. A $50 loan may not attract the attention of corrupt government officials, but a $50,000 or 100,000 loan inevitably will.


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