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Chapter 2. How the Other Half Finances
If I had my way I would write the word “Insure” over the door of every cottage, and upon the blottingbook of every public man, because I am convinced that by sacrifices which are inconceivably small,
which are all within the power of the very poorest man in regular work, families can be secured against
catastrophes which otherwise would smash them up for ever. — Winston Churchill, 19091
I believe that all human beings are potential entrepreneurs. Some of us get the opportunity to express this
talent, but many of us never get the chance because we were made to imagine that an entrepreneur is
someone enormously gifted and different from ourselves. — Muhammad Yunus, 20042
Perhaps you remember when you first learned about microcredit. Did it surprise you that one could help
the poor by putting them in debt? The root of that surprise is the microfinance movement’s success in
replacing, in the public mind, the old story of lending to the poor—on one of usury and entrapment—
with a new one: after all, it seems, the poor are not so locked in by the lack of money that credit will only stave off hunger for a few weeks, then leave a residue of hopeless liabilities. Instead, the poor are
masters of their fates, incipient entrepreneurs who only lack credit to bloom.
Of course, each of the stories is true sometimes, and neither is true always. Thus is an irony in
this modern myth-remaking. The microfinance movement has rightly been animated by a belief that the
poor are no less creative or ambitious for being poor. But to live up to that spirit of respect, we ought to
minimize our preconceptions about how the poor do and ought to use financial services. Let us define
the global rich as the billion or so people who live in relative material comfort and security. If you belong to this group, you can see that your peers are a diverse group, using financial services such as savings and loans and insurance in diverse ways with diverse outcomes. The experiences of the 5 billion or
so poor people are at least as varied. Some get trapped in debt. Others, whom we call microentrepreneurs, do borrow money to stock up their corner stores or invest in goats. But even those two stories are
not the “whole story.” A family might save to prepare for a wedding, buy insurance to dampen the
feared shock of a father’s death, or borrow for antibiotics for an ill son.
1
2
Churchill (2007 [1909]), 146–47.
Yunus (2004), 207.
1
Roodman microfinance book. Chapter 2. DRAFT. Not for citation.
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Poor people, like everyone else, want financial services for many purposes in addition to starting
a business. If anything, in fact, people living close to the jagged financial edge need financial services
more than the rich. Unfortunately, and inevitably, while the better-off can usually find services tailored
to specific needs, from mortgages to life insurance to retirement accounts, those less fortunate must
choose from lower-quality options, which thus are often not well matched to the needs at hand. As the
authors of the seminal 2009 book Portfolios of the Poor have shown, the poor must patch together unreliable or inflexible services—loans from friends, store credit, neighborhood savings clubs, and microcredit—to manage money as best they can.3 This book asks what microfinance does for the poor. Let us
start our investigation from the client’s point of view.
How the rich use financial services
The global rich have access to a spectacular variety of financial services: checking and savings accounts,
home mortgages, car loans, credit cards, mutual funds, retirement funds, brokerage accounts, insurance
for cars, houses, health, life, and disability….Just as it is hard for a New Yorker who samples a new restaurant each week to ken the life of a Guatemalan highlander subsisting on tortillas, so is it hard for
those who enjoy a wealth of financial services to empathize with a woman for whom saving means hiding money from her husband in the folds of her sari.
Despite the gulf in experience, the rich can gain insight into the poor’s use of financial services
by contemplating their own. Try this exercise. List all the financial services you have used. For each,
determine what it helps you do. Transact? Invest? Spend money you have not yet earned? Then confront
this question: if you had to give up all these services but one, which would you keep? Here is my full
list. It is fairly representative for middle-class American families; but even if you consider yourself part
of the same group, your list will probably differ:
3
Collins et al. (2009).
2
Roodman microfinance book. Chapter 2. DRAFT. Not for citation.
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Table 1. My financial services
Service
Purpose
Savings account
Prepare for emergencies such as job loss
Checking account
Transact over long distances or in large amounts without cash
Wire transfer
Send and receive money internationally (rare)
PayPal account
Send money to friends; buy things online
Credit cards
Transact without cash; buy things I want before I have the money
Home mortgage
Live in a home I own before I can pay for it
Home equity line of credit Ditto; and cheap credit to improve house
Car loan
Get a car before I can pay for it
Student loan
Invest in my own skills, for higher pay after graduation
College savings
Prepare to do the same for my sons
Retirement savings
Prepare to support myself when I no longer work
Health insurance
Protect family against financial catastrophe in event of serious health
problems; assure access to care
Homeowner’s insurance
Protect family against financial catastrophe in event of serious harm to
home
Automobile insurance
Protect family against financial catastrophe in event of serious harm to
car, or liability for accident
Umbrella liability insurance Protect family from liability suits in general
Life insurance
Protect family against financial catastrophe if I die
Disability insurance
Protect family against financial catastrophe if I am unable to work
If you I showed and explained this list to a microfinance client, the luxury would become obvious—the variety and low cost of the services, the college education foreseen, the home valued in six
figures. But if I articulated the needs that underlie my use of these services, we might understand each
other well. In scanning the list, I discern four major and universal purposes:
1. To transact. The credit cards and checking account help me move sums too large to be safe
in my wallet. They also help me send amounts large and small over long distances. And they
make it all easy. My paycheck goes into the checking account automatically; the mortgage
payment comes out just as smoothly. A swipe of a card at the pump pays for gas.
2. To invest. I need to sacrifice now to have more later. I borrowed to help pay my college tuition, and I invest in a fund to do the same for my two sons. Notably, like most people in rich
3
Roodman microfinance book. Chapter 2. DRAFT. Not for citation.
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countries, I have not used financial services to invest in my own business, for I have none. I
prefer the stability of the salaried job I am fortunate to hold.
3. To build assets. Notice what I did not mention just above under the heading of investment:
buying a house: Some people ascribe an investment purpose to the home mortgage. But I
bought my house for other reasons. In fact, on general principles, a mortgage-financed home
is a terrible investment. It puts a lot of financial eggs in one basket, violating the principle of
diversification. Using credit to buy the home—investing with leverage—multiplies the risk
as housing market crashes and foreclosure epidemics have made obvious in several countries.
And homes can be hard to sell ( “illiquid” in investmentspeak). Why then make such a terrible investment decision? Owning a home (or bicycle or cow) brings a degree of security..
Someone who holds title to her home need not worry about being forced out by a landlord
who does view the building as an investment. Home ownership also strengthens communities
by increasing the interdependence: what one neighbor does to her property affects the value
of others’. A more collective view encourages people to work together on local institutions
such as schools. And secure people think longer-term: a farmer is more apt to husband land
he owns than land he leases. Finally, as Peruvian economist Hernando de Soto has famously
argued, title to a major asset can also serve as collateral for credit.4 I once borrowed against
my house to fix the roof, and could borrow again as another way to help put my sons through
college.
4. To sustain consumption. I was struck to discover that most of the services on my list serve to
secure my family’s access, through thick and thin, to necessities such as food and clothing.
The savings account is a safety net if I lose my job. Retirement savings should let me buy
what I need when I earn nothing. Credit cards and the home loans let us marshal big sums
4
de Soto (2000).
4
Roodman microfinance book. Chapter 2. DRAFT. Not for citation.
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without starving. The insurance policies take the financial bite out of life’s traumas.5 Economists call this function consumption smoothing. And to respond to the challenge I posed earlier, if I was told I had to live with just one financial service, I would beg for two, both of
which smooth consumption: life and health insurance. They protect my family from bankruptcy in the face of life’s worst.
We can learn more lessons from this exercise. First, risk is intimately intertwined with money.
Insurance policies put risk front and center. But they are not unique in involving it, for whenever one
party to an agreement to provide financial services commits to delivering money under certain circumstances at some future date, there is risk. Perhaps a borrower will not repay, or a bank holding deposits
will go under. Second, many financial services bind even as they serve. The mortgage and other loans
force me to set aside money each month to make the payments. Before retirement, the retirement accounts can only be accessed at a penalty. In appropriate doses, this discipline is healthy; we all need help
resisting the temptation to fritter away today. Of course, sometimes discipline becomes punitive. This
double-edged nature, of credit especially, is the germ of the ancient and unresolved debates over precisely what constitutes just lending.
Third, the set of financial services you use depends on who you are. If I were a poor American,
my inventory would be quite different. I might not have the steady job that makes me an attractive risk
to mortgage lenders. My compensation might not include a retirement plan. I might have trouble maintaining a minimum balance in a checking or savings account. And, to borrow a term from the Commission on Thrift, a coalition of U.S. non-profits, the “concierge services” of government-subsidized retirement and college savings accounts would probably disappear from my list.6 So might all the insurance policies and the checking account. In their place might appear check cashers and payday lenders
5
Perhaps I should also have listed the government insurance programs my employer pays into on my behalf, to aid me when
I retire, or before then if I lose my job.
6
Commission on Thrift (2008).
5
Roodman microfinance book. Chapter 2. DRAFT. Not for citation.
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extending credit at 400 percent per annum. Just as there are more drugs for male impotence than malaria, the financial services available to the rich outshine those within reach of the poor—in quality, diversity, and cost. This too is worth noting: my wife’s inventory is identical to mine. But in many countries,
law and custom keep women out of formal finance.
Perhaps the most important lesson from this exercise is about how financial services, like roads
and piped water, undergird the comfortable life. Imagine having to conduct your life without financial
services: no bank accounts, no bank loans, no credit cards, no insurance, not even payday loans…just
cash. The intangibility of these services belies their importance. Their chief benefit, I would argue, is in
serving the purpose on my list: helping people manage and maintain consumption during lean seasons
and catastrophes. In the vocabulary of Amartya Sen, financial services give people more agency, more
control over their lives—more freedom. However, as Sen emphasizes, freedom begets freedom. Those
who already have more agency, thanks to being rich or male, say, can access better services.7 Those who
come to the financial service marketplace with fewer advantages leave with fewer.
The financial challenges of the poor
In comparing and contrasting the rich and the poor, the famous exchange between F. Scott Fitzgerald
and Ernest Hemingway comes to mind. “The rich are different from us,” Fitzgerald observed. “Yes,”
retorted Hemingway, “they have more money.”
Actually, that never happened. The story is a Hemingway fiction, a put-down of his rival’s fascination with the rich.8 But this apocryphal exchange does capture a real question for us: is there much
difference between being rich and being poor? When it comes to solving financial problems, are rich the
same as poor, except with more money?
7
8
Sen (1999).
Berg (1978), 304–05.
6
Roodman microfinance book. Chapter 2. DRAFT. Not for citation.
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Yes and no. Broadly, rich and poor are no different: all need to transact, invest, build assets, and
sustain consumption. On the other hand, the financial circumstances of the poor are qualitatively, not
just quantitatively, distinct. Their needs, especially to sustain consumption, are more acute, and the
strategies they use to meet those needs are in several respects quite different.
Poor families, for example, are more apt to dispatch members to find work. Migrating for work
can increase earnings as well as smooth them through spatial diversification. Living in 1995–96 in a village in southern Bangladeshi served by the Grameen Bank, graduate student Sanae Ito discovered that
the surest way for residents to get out of poverty in that village was to get out of the village. A family
would save up or borrow to send a spouse or child to the capital, Dhaka, to do day labor or even get a
job.9 In Kenya, the wildly popular mobile phone–based money transfer service, M-PESA, got its start
with the slogan “Send Money Home.” The target client lived in Nairobi and needed safe ways to send
funds to his parents, wife, or children in the countryside.10 Bangladeshi and Kenyan villages also export
workers even farther afield. Bangladeshi men working construction and other jobs in the Middle East are
sending macroeconomically significant flows of money homeward. Many Kenyans go to the U.K. Companies such as Western Union and MoneyGram help these workers remit funds across borders. In Bangladesh, BRAC Bank, a spin-off of the giant non-profit BRAC, has teamed up with Western Union to
turn its branches into money transfer points. In Kenya, Safaricom, the creator of M-PESA, is working to
bypass money transfer major by extending its network internationally. (See Figure 1.) Already, amazingly, M-PESA does more transactions domestically than Western Union does globally.11
9
Ito (1999).
Mas and Radcliffe (2010), 9.
11
Ibid.
10
7
R
Roodman miicrofinance book.
b
Chapter 2. DRAFT
T. Not for ciitation.
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F
Figure 1. Po
osters for international money tran
nsfer througgh BRAC B
Bank and W
Western Unioon in
B
Bangladesh and throug
gh M-PESA in Kenya
((Photos by author)
Anoth
her precarious aspect off poverty is th
he difficult oof obtaining and protectiing major asssets.
T
The poor, lik
ke the rich, can
c benefit im
mmensely frrom the secuurity that com
mes with ow
wning farm laand or a
hhouse. But obtaining succh things and
d protecting them from fflood, fire, annd theft is a more fraughht enterpprise. One caan see the im
mportance off asset ownerrship for the poor in an iincident in A
Argentina. Inn 1984,
tthe government of Bueno
os Aires mov
ved to give 1,800
1
squattter families oon the outskiirts of the citty title to
lland on whicch they lived
d. Eight of th
he 13 legal ow
wners of thee land acceptted the city’ss buyout, whhile the
rrest fought th
he expropriaation in courtt for twenty years.
y
Thus some squattters lucked oout in quicklyy gaining title whille others did not—a circu
umstance wh
hich, howevver cruel andd arbitrary, m
made gold forr re-
8
Roodman microfinance book. Chapter 2. DRAFT. Not for citation.
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searchers, in the form of a “natural experiment.”12 The Wall Street Journal sketched the consequences
for the squatters:
Mercedes Almada and Valentín Orellana both live in San Francisco Solano, a barrio settled by squatters
almost 25 years ago on the fringes of the Argentine capital. They established households on identically
sized lots and worked similar blue-collar jobs for comparable wages—she in sewing, he in a factory. They
endured the same hardships, including an effort by Argentina's 1980s military government to bulldoze the
settlement.
Then, Mrs. Almada gained title while Mr. Orellana did not.
Today, Mrs. Almada lives in a neat colonial-style home with a slab roof supported by pillars as solid as
oaks. The six members of the Almada household have rooms of their own. A daughter finished high
school and one son finished technical school.
Mr. Orellana’s house is made of rough looking cinder blocks and concrete, with thin posts supporting a
corrugated zinc roof. It is so cramped that some of the eight family members have to sleep in the dining
room and kitchen. None of the children [has] made it past seventh grade.13
The reporter may have chosen extreme examples to show the fork in fates. But statistics back up the vignette. Argentine researchers Sebastian Galiani and Ernesto Schargrodsky found that title-holders invested more in their homes and the education of their children.14
Thus we see that the poor, like the rich, need to build assets, just as they need to transact over
long distances. But their needs have a different timbre. The same goes for the other two purposes I identified in inventorying my financial services: The poor also try to invest for the future. And above all they
strive to assure steady access to necessities despite life’s vicissitudes.
But here the rich-poor difference is so great that to view poor people as rich people with less
money is to completely misunderstand their financial lot. The poor are short of money, yes, but also of
control over their financial circumstances. Their incomes and spending needs are more variable and unpredictable, their lives more dangerous. Perhaps the most important financial distinction between poor
and rich—leaving aside the superrich—is that by and large the rich have salaries. My steady paycheck
12
Galiani and Schargrodsky (2005).
Moffett (2005).
14
Galiani and Schargrodsky (2005).
13
9
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rivals all my insurance policies in bestowing financial security. It allows me to think long-term, helping
me invest in, among other things, my children. And it makes me more creditworthy, helping me borrow
to build up assets. Surveying findings from household surveys done in 13 developing countries, MIT
economists Abhijit Banerjee and Esther Duflo found that what most statistically distinguished people
earning more than $2 a day from those living on less was not education or health, or even wealth, but
holding a steady job.15 To put that another way, as I wrote in chapter 1, most people who live on $2 a
day don’t live on $2 a day: they earn $4 one day, $1 the next, $3 the day after that, and so on. Or perhaps
they make money once a season, when they sell their crops. Characterizing poor people as earning some
number of dollars per day thus misses the fundamentally different nature of their income. The variability
matters at least as much as the average.
No work has made this reality clearer to the world’s salaried minority than Portfolios of the
Poor, the book by Darryl Collins, Jonathan Morduch, Stuart Rutherford, and Orlanda Ruthven. Following a suggestion some ten years ago by the University of Manchester’s David Hulme, Rutherford and
other researchers began working with a few dozen families in Bangladesh to collect detailed financial
transaction logs called financial diaries. Later work extended the methodology to a few hundred families in India and South Africa. Typically, a researcher visited a household every two weeks over the
course of the year to update the logs, noting down every day wage and rice purchase, every instance of
saving, borrowing, and repayment. Among the stories revealed in the diaries, and in the book, is that of
Pumza, who cooks and sells sheep intestines out of a stall in Cape Town. Net of spending on firewood
and raw intestines, Pumza makes $95 a month on average; adding a $25 child support grant brings her
monthly income to $120, which works out for Pumza and her four children to $0.80 per person per day.
15
Banerjee and Duflo (2008). The authors use purchasing power parities to convert to U.S. dollars.
10
Roodman microfinance book. Chapter 2. DRAFT. Not for citation.
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Hidden within that average, however, is a great deal of unpredictability and volatility—day to day,
month to month. (See Figure 2.)16
Figure 2. Fortnightly revenues, expenses, and profits of Pumza, March 20–November 27, 2004
$100
$90
Revenues
$80
Profits
$70
$60
$50
$40
$30
Expenses
$20
$10
Used moneylender
Used savings
club payout
Converted using $1 =
6.5 South African rand.
Source: Collins et al. (2009), 41.
$0
20-Mar
17-Apr
15-May
12-Jun
10-Jul
7-Aug
4-Sep
2-Oct
30-Oct
27-Nov
The human body, however, does not do so well on a diet that alternates feast and famine. The
children should eat every day. The collision between volatile income and constant needs creates an intense demand for ways to set aside money on good days, or good seasons, and pull it out on bad. But the
challenge is not purely financial: it also psychological and social. In theory, people should be able to
handle the volatility by putting enough money under the mattress on the good days. In practice, that discipline is hard to muster. With the cash sitting right there, beer and sweets and cigarettes are harder to
resist. With the cash sitting right there, family members asking for a share are harder to deny. Thus the
16
Collins et al. (2009), 40–42.
11
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arm’s length, businesslike nature of financial services is part of their value, for they help people remove
money from their homes and bind themselves to better behavior. Twice during the period graphed in
Figure 2, for example, Pumza’s profits went slightly negative. The first time, she used a payout from a
savings club (a ROSCA, explained in chapter 3) to tide herself over. The second time she went to the
moneylender.17 Both these mechanisms helped her commit herself to setting aside money when she
could while resisting temptations and relatives’ pleas.
As if living with a volatile income wasn’t hard enough, what a poor family spends also tends to
be more unpredictable, above all because of illness. Most poor people lack health insurance; yet disability and death are more frequent visitors at their doorsteps.18 Again summarizing household surveys from
many countries, Banerjee and Duflo found that, depending on the country, 11–46 percent of households
below a dollar a day had someone who had been bedridden or had needed a doctor within the last
month.19 Together, the loss of income when a breadwinner takes sick and the cost of pills and doctors
can undo years of assiduous saving and asset-building, plunging a family into destitution. One day in
1989, recounts Portfolios of the Poor, a Bangladeshi rickshaw driver named Salil came home to his
wife, complaining of a sore throat. He consulted a series of doctors. To pay them, he sold off his three
rickshaws one by one, the capital of his livelihood. The doctors did not help. Salil ended up going to the
hospital, where he was diagnosed with throat cancer and died within days. Through the whole period,
bereft of income, his wife had borrowed to support the couple and their three small children. “His widow and family were left without a breadwinner, without assets, and saddled with debts.” They became
the poorest Bangladeshi household in the financial diaries studies.20 They did not have health and life
insurance like me. If Salil’s story is unusual, it is so only in degree, not kind. Fifty percent of the Bang17
Ibid.
On income volatility, see Morduch (1995).
19
Banerjee and Duflo (2007), 149. The poverty line is $1 of household spending per member per day, converted to local currency using purchasing power parities.
20
Collins et al. (2009), 86–87.
18
12
Roodman microfinance book. Chapter 2. DRAFT. Not for citation.
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ladeshi financial diary households experienced illness during the yearlong study period, as did 42% of
Indian ones. Fully 81% of the households in South Africa, where AIDS is common, experienced the financial emergency of a funeral.21
The exaggerated myth of microentreprise
One common strategy for managing risk on the income side of the ledger is diversification. A survey of
27 villages in West Bengal, India, found that households typically had three workers, who among them
practiced seven occupations.22 Banerjee and Duflo found that a fifth of urban households in Peru living
on less than $2 a day per person earn from more than one source, as do a quarter in Mexico, a third in
Pakistan, and half in Côte d’Ivoire.23 In the extremely poor district of Udaipur in the Indian state of Rajasthan, almost everyone owns and farms some land, but 74 percent of those with incomes below a dollar a day earn most of that income in day labor—working for others without the security of long-term
employment.24
Naturally, people with multiple income sources are not juggling multiple jobs. Rather, selfemployment is common—more so than among the rich. It was reported among a quarter of poor and rural households in Guatemala and a third in Indonesia and Pakistan.25 Banerjee and Duflo explain the attraction of working for oneself:
If you have few skills and little capital, and especially if you are a woman, being an entrepreneur is often
easier than finding an employer with a job to offer. You buy some fruits and vegetables or some plastic
toys at the wholesalers and start selling them on the street; you make some extra dosa [rice and bean pancake] mix and sell the dosas in front of your house; you collect cow dung and dry it to sell it as a fuel;
you attend to one cow and collect the milk. These types of activities are exactly those in which the poor
are involved.26
21
Ibid., 68.
Banerjee and Duflo (2007), 152. “Typical” figures are medians.
23
Idem (2007), 152.
24
Ibid., 151.
25
Ibid., 152.
26
Ibid., 162.
22
13
Roodman microfinance book. Chapter 2. DRAFT. Not for citation.
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Self-employment, then, is one response to being poor in a poor country. But thanks to the promotion of
microcredit, it has become something much more in the public imagination. It has become microenterprise: not just a response, but a solution; and not just one reason the poor want financial services but the
reason. It is true that the global poor, more than the global rich, must fend for themselves economically.
So the image of the poor as microentrepreneurs is not pure mythology. But overall, they, like everyone
else, use a variety of financial services for a variety of purposes.
As a result, arrangement through which rich investors finance microcredit tend to become chains
along which funds travel—while perception and reality collide.27 A user of Kiva, the on-line peer-topeer microcredit site, might lend money to one of the “entrepreneurs” listed on the website. The funds
would go to Kiva, then to a local microcreditor, then to a borrower rather like the one pictured on the
site.28 That borrower might use the credit for microenterprise…or might not. The more a fundraiser like
Kiva exaggerates the role of microenterprise in order to raise funds, such as by calling all clients “entrepreneurs,” and the more that microfinance institutions describe themselves as supporting the same, the
more that point of collision is pushed toward the client. What clients really do with the credit, which is
elusive under the best of circumstances, falls further below the radar of the investor and the intermediaries. When asked how they use a service, microfinance clients often give the answer they believe is wanted. They respond this way out of ordinary self-interest; to ignore self-interest is a luxury the poor cannot
easily afford. In Bangladesh, a borrower’s husband told anthropologist Lamia Karim with a smile that
“We took a cow loan. Fifty percent will be spent to pay off old debts, and another fifty percent will be
invested in moneylending. If the manager comes to see our cow, we can easily borrow one from the
neighbors.”29 Sometimes the obfuscation is more subtle, and even unconscious. This is because what a
27
Recall from chapter 1 that by “investor,” I mean all those who finance microfinance, whether through gifts, loans, or equity
investment.
28
Borrowers pictured on Kiva
29
Karim (2008), 16.
14
Roodman microfinance book. Chapter 2. DRAFT. Not for citation.
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person appears to use a loan or savings drawdown for can and what it enables her to do are two different
things. Beatrice, the female half of an entrepreneurial couple in Zambia’s Copperbelt, explained to British researcher James Copestake that, in his words, “the main difference the loans had made over the last
year was in freeing their own capital for construction of their house.” Microcredit loans formally went
into the business, but only by supplanting the couple’s own capital into personal uses.30 So in fact the
microcredit went for home improvement.
The Malaysian journalist Helen Todd succeeded better than most in piercing this fog, giving us a
rare statistical view of what one service, microcredit, actually allowed poor people to do. Throughout
1992, she and her husband David Gibbons, who was also studying microfinance, lived amid two villages
in the Tangail district of Bangladesh, one of the first regions in which the Grameen credit program operated on a large scale. With a research team that included Bangladeshis, they tracked the financial and
personal lives of 62 women, 40 of whom borrowed from Grameen, in a way that foreshadowed the financial diaries. Todd and her team complemented their quantitative data with “qualitative” evidence—
hundreds of conversations and observations over the course of a year. Table 2 shows their tabulation of
how the 40 borrowers said they would use the credit, in order to obtain loan approval, and how they actually used it. All the stated purposes were investments. “According to the [Grameen] Bank records,”
Todd writes,
35 of our 40 member sample took loans in 1991/92 for either “[rice] paddy husking” alone or “paddy
husking/cow fattening.” As far as we could tell, only four women did any paddy husking for sale during
the year and that only for limited periods. Two young women who lived in the same bari [or homestead
lot] had taken their last few loans for “cow fattening.” Although I was in and out of their bari for seven
months of the year, I never saw hide nor hair of any cows.31
As expected in light of the data from Banerjee and Duflo, Todd’s data in Table 2 do not entirely
debunk the image of poor women as microentrepreneurs. Four women really did appear to take loans for
30
31
Copestake (2002), 746.
Todd (1996), 25.
15
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cows, and another two invested in equipment or stock for back-breaking work of grinding mustard seeds
for oil. Three more bought rickshaws, presumably for their husbands to use as a source of income. But
clearly more was going on. Some women used the loans to pay dowry, breaking a vow they took as
Grameen members.32 Others bought rice. Some improved the roof or walls of their small homes. In fact
a majority did use the credit for what can be considered business activities, though not ones usually
thought of as microenterprise: moneylending and the leasing or buying of rice land. Bank policy proscribed land leasing in particular, viewing the rents as usury extracted by landlords, a perspective which
reflects the history intertwining of moneylending and land monopoly. But for many families, leasing
land was a step up in security and freedom: instead of working someone else’s land for a daily wage set
by someone else, the husband could plant and manage the family’s “own” field. Once during the research project, Grameen Bank founder Muhammad Yunus visited Todd and Gibbons, who briefed him
on their findings. They urged him to allow land leasing:
Dr Yunus listened but did not commit himself.
“Let’s go to the village,” he said.
…
Professor Yunus questioned Kia [a borrower] about [a new] loan. “Do you want one?”
“Yes, sir!”
“What will you use it for?”
I saw Kia hesitate for a moment. Then she looked the Managing Director in the eye.
“I won’t lie to you,” she said. “I am going to lease in some land.”33
In that moment, Yunus’s notion of how the poor ought to use credit collided with the notions of the poor
themselves—somewhat ironically, given his expressed faith in the ability of the poor to find their own
way with the help of credit.
32
The custom of paying dowry makes girls economically burdensome and boys lucrative, reinforcing discrimination against
girls within families.
33
Ibid., 16–17.
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Table 2. Approved and actual use of Grameen Bank loans to 40 women, 1992
Amount of loans (taka )2
Approved
Actual
Rice paddy husking
73,500
Rice husking/cow
46,000
Cow
42,500
19,300
Mustard oil grinding
23,000
5,760
Grocery trade
5,000
Mustard oil/sweets
5,500
Land transactions
70,320
Loan repayment
24,720
Stocking rice
27,134
Lending
6,849
Rickshaw
6,137
Dowry/wedding
5,075
Housing materials
4,680
Other/unknown
25,025
1
Loans put to more than one use listed more than once. 2$1 = 40 taka .
Source: Todd (1996), 24.
Number of loans
Approved
Actual1
20
8
7
4
4
2
1
1
20
16
12
7
3
2
1
This kind of mythologizing is also embedded labels applied to people who work for themselves
as a matter of survival. In the 18th and 19th centuries in the British Isles, such people were “industrious
tradesmen.”34 Some on the Continent some saw them through the lens of the labor-capital divide—as
workers who could become small capitalists.35 Today, rickshaws drivers and mustard grinders are often
said to be running “microbusinesses.” They are “microentrepreneurs.” These fusions of a silicon-era prefix with a capitalist projection appear to have originated with a volunteer for Acción International named
Bruce Tippett in 1974, not long after “microprocessor” entered the language.36 “Microentrepreneur” is
apt in important respects, for the people so labeled risk their tiny bits of capital, work for themselves,
and reap the profits and loss of their operations.
But unlike the prototypical rich-world entrepreneur, few “microentrepreneurs” draw in new investors, innovate, expand, or create jobs. They do not abandon steady employment in order to launch
themselves into bold ventures. Rather, they are quite conservative in investing in themselves. Evidently,
34
E.g., Piesse (1841), 9.
E.g., Wolff (1996), 2, 10, 16, 19.
36
Jeffrey Ashe, Director of Community Finance, Oxfam America, Boston, MA, interview with author, November 26, 2008.
35
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living on the edge curtails one’s appetite for risk. An experiment in Sri Lanka showed that injecting
modest additional capital into microenterprises let the owners earn average returns of 5 percent per
month (about 60 percent per year), far higher than what most major corporations earn.37 The same experiment in Mexico generated returns exceeding 20–33 percent per month.38 Presumably, the law of diminishing returns would set if these microenterprises grew to become less “micro.” Why poor people
don’t push farther toward the point of diminishing returns, why they leave these winnings on the table, is
not fully clear. They may not recognize the opportunities to sew more saris or better stock their shelves.
They may struggle to pull together the lump sums needed to invest. Perhaps microbusinesses are like
tech stocks—high return on average but also high risk—and to reduce risk, people spread their eggs
among many baskets. Whatever the cause, poor entrepreneurs are apparently less venturesome than they
could be. All in all, they are not the agents of creative destruction whom economist Joseph Schumpeter
saw as the heroes of economic development. They undertake—to revert to the root meaning of “entrepreneur”—mainly to survive.39 To this extent, labeling them “microentrepreneurs” romanticizes their
plight and implies too much hope for their escape.
A somewhat older and now less fashionable view of poor entrepreneurs, historically associated
with the International Labor Organization, is as victims of economic systems that fail to provide enough
jobs. To put this more constructively, since the Industrial Revolution, explosive job creation has powered all national economic development successes. Comprehensive economic development is hard to
imagine without jobs. In this view, the people of whom we speak have not benefited from such devel-
37
de Mel, McKenzie, and Woodruff (2008a).
McKenzie and Woodruff (2008). Other studies have found similar conservatism among poor farmers in deciding, for example, whether to apply commercial fertilizer. See Morduch (1995), 105.
39
de Mel, McKenzie, and Woodruff (2008b).
38
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opment. They are “people without jobs” or “self-employed” or “own-account workers” who heroically,
but tenuously, survive their circumstances.40
We do not need to choose between seeing the poor as victims or masters of their own fates, as
microentrepreneurs or people without jobs, for there is truth in both views. One’s economic possibilities
are very much defined by economic circumstances beyond one’s control. Given those circumstances,
financial services can help people manage better. Microfinance may not reliably help people climb out
of poverty, but it can help them manage it better, in part, indeed, through microenterprise.
How the poor use financial services
Having disenthroned one common but narrow view of how poor people use financial services, it remains
for us to forge or find or a more realistic view. Perhaps no one is a better interpreter of how poor people
manage money than Stuart Rutherford. A trim man with thin-rimmed glasses and a dusting of white hair,
he loves nothing more than interviewing people about they handle their finances. Trained as an architect,
he became interested in the subject while investigating the effects of the earthquake in Managua just before Christmas in 1972. There, as in Haiti in 2010, many slum dwellers lost their homes. Yet somehow
they summoned the financial resources to rebuild rapidly, confounding many foreign aid officials. In his
2000 book, The Poor and Their Money, Rutherford focuses less than I have on the purposes for which
the poor use financial services, and more on the transactions involved. At base, he argues, poor people
need financial services in order to turn small, regular savings into “usefully large sums.” These sums can
go toward three of the four purposes I discovered in my inventory: investment, gaining ownership of
assets, and managing consumption.41 The last, as we have seen, is essential. As one poor Bangladeshi
told Rutherford, “I don’t really like having to deal with other people over money, but if you’re poor,
40
41
ILO (1993), §§7, 10.3.
Rutherford (2000), 1.
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there’s no alternative. We have to do it to survive.”42 Rutherford emphasizes how three specific types of
financial service—loans, savings, and insurance—all help people with the core task of assembling large
sums. Through all of these services, people can make small, regular payments—loan service, savings
deposits, insurance premiums—and take occasional large pay-outs. As a matter of money flow, the services differ only in timing of the ins and outs.
Borrowing and saving, in particular, are not nearly so opposite as they appear. Rutherford illustrates their similarity with two examples he and his research partner Sukhwinder Singh Arora found in
the slums of Vijayawada, a city in southeastern India. The first example is of savings:
Jyothi is a middle-aged semi-educated woman who makes her living as a peripatetic (wandering) deposit
collector. Her clients are slum dwellers, mostly women. Jyothi has, over the years, built a good reputation
as a safe pair of hands that can be trusted to take care of the savings of her clients.
This is how she works. She gives each of her clients a simple card, divided into 220 cells….In
each cell, clients commit themselves to saving a certain amount in a certain period. For example, one client may agree to save five Indian rupees (Rs 5) [about 10¢] per cell at the rate of one cell a day….Having
made this agreement it is now Jyothi’s duty to visit this client each day to collect the five rupees…
When the contract is fulfilled—that is when the client has saved Rs 5, 220 times…the client takes
her savings back. However, she does not get it all back, since Jyothi has to be paid for the service she
provides. These fees vary, but in Jyothi’s case it is 20 out of the 220 cells—or Rs 100 out of the Rs 1,100
saved by the client in our example.43
Notice that Jyothi does not pay interest on deposits as conventional banks generally do; she charges—at
a rate that works out to 30 percent a year.44 Rutherford asked Jyothi’s clients why they pay so much to
save when stashing cash in a box is free:
The first client I talked to…knew she would need about Rs 800 in early July, or miss out on admitting her
children to school. Her husband, a day labourer, could not be relied on to come up with so much money at
one time, and in any case he felt that looking after the children’s education was her duty, not his. She
knew she would not be able to save so large an amount at home—with so many more immediate demands
on the scarce cash. I asked her if she understood that she was paying 30 per cent a year….She said that
she did, and still thought it a good bargain….[D]wellers in a neighbouring slum where there is no Jyothi
at work actually envied Jyothi’s clients.45
42
Collins et al. (2009), 13.
Ibid., 13–14.
44
As discussed below, steady repayments over the loan period make the average balance half the starting balance and approximately double the effective interest rate.
45
Ibid., 15–16.
43
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Bankers call Jyothi’s service a “commitment savings account.” By removing a bit of money from
the house each today, Jyothi protects her clients from pressures to spend too much now. Jyothi facilitates
thrift. Paradoxically, commitment savings ties the clients’ hands in a way that strengthens their control
over money and power in the family. Poor people do have other ways to save, such as in jewelry and
livestock. But thieves can take rings and pigs can die. And such assets are inconvenient: as one Indonesian pointed out, “when you have to pay the school fees, you cannot sell the cow’s leg.”46
In India, Rutherford also talked to clients of a moneylender, whose
…working method is simple. He gives loans to poor people without any security (or “collateral”), and
then takes back his money in regular instalments over the next few weeks or months. He charges for the
service by deducting a percentage (in his case 15 per cent) of the value of the loan at the time of disbursal.
One of his clients reported the deal to me as follows.
“I run a very small shop” (it’s a small timber box on stilts on the sidewalk inside which he squats
and sells a few basic household goods) “and I need the moneylender to help me maintain my stock of
goods. I borrow Rs 1,000 from him from which he deducts Rs 150 as interest. He then visits me weekly
and I repay the Rs 1,000 over ten weeks….As soon as I have paid him off he normally lets me have another loan.”
This client (Ramalu) showed me the scruffy bit of card that the moneylender had given him and
one which his weekly repayments are recorded. It was quite like the cards Jyothi hands out.47
The similarities to Jyothi’s commitment savings service are striking. The moneylender too uses grids
printed on cards to track payments. Both the savings and credit services operate cyclically, producing
the same predictable rhythm of frequent, small pay-ins and infrequent, large pay-outs.
Perhaps most importantly, both provide discipline. They help people set aside money each day or
week and resist what must be strong temptations to spend or hand over it all. The financial services do
this by both reminding and binding. This distinction might surprise. Is not discipline synonymous with
compulsion? Not quite. A study in Bolivia, Peru, and the Philippines found that people with voluntary
savings accounts saved 6% more on average if they received regular text message reminders to save.48
Evidently, the reminders helped them summon self-discipline. And evidently, part of the value of a loan
46
Robinson (2002), 264.
Rutherford (2000), 17–18.
48
Karlan et al. (2010), 39.
47
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repayment schedule, binding as it is, lies simply in regularly drawing clients’ attention to the priority of
setting money aside.
Here too we see financial services meeting a need that the rich also experience, if less intensely
than the poor. Discipline is more difficult where money is tighter and life is less predictable. A study in
Hyderabad, India, found that offering microcredit reduced household spending on “temptation goods”
such as tea and cigarettes, and increased spending on durable goods such as sewing machines.49 In the
slums of Nairobi, researchers Siwan Anderson and Jean-Marie Baland found that 84 percent of participants in local savings clubs known as ROSCAs were women.50 And among women, the ones most likely
to join were neither those earning all the household’s income nor none of it, but those in between.
Roughly speaking, sole breadwinners did not need the leverage (with respect to husbands) of a commitment savings arrangement; non-breadwinners had no income to leverage. And evidently, women needed
the leverage with respect to their spouses more than men. In their paper, “Tying Odysseus to the Mast,”
economists Nava Ashraf, Dean Karlan, and Wesley Yin discovered the same need in the southern Philippine island of Mindanao. Working through a rural bank, they offered a new commitment savings account to randomly picked customers. Interestingly, even though the commitment account locked up clients’ money, it did not pay a higher interest rate than the bank’s ordinary savings account. Yet 28 percent of customers who got the offer took it. After one year, those offered had saved 81 percent more
than those not. Women in whom psychological tests revealed a strong tension between how they manage
money in the moment and how they wish they could over the long term were more likely to join than
49
Banerjee et el. (2009), [xx].
Anderson and Baland (2002). The rotating savings and credit associations (ROSCA) is the most prevalent form of informal
financial service. See chapter 3.
50
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other women, and more than men in general.51 Evidently some of them recognized their need for external discipline.
To the extent that financial services resemble one another, they can substitute for one another.
One woman might save to buffer her family against the possibility of a husband taking sick. Another
might avail herself of rudimentary health insurance such as that offered by the group SHARE Microfin
in India.52 Another might borrow to pay clinic fees when needed. A survey in the Indian state of Karnataka found that 40 percent of households included someone who had suffered an expensive health problem in the last year. 67 percent of these tapped savings to help pay the bills and 44 percent borrowed. 53
But this is not to suggest that poor people could happily switch between savings, credit, and insurance. These types of financial services are neither perfect substitutes for each other nor freely substitutable. In Karnataka, only 0.3 percent of the households with health troubles drew on insurance, which
is not surprising since almost none could buy any. Few could swap in this superior service to replace
savings or credit. By and large, the poor must self-insure. And the intuition that credit and savings are
deeply different does contain truth. Fundamentally, they impose different risks on clients. With savings
(and insurance) the client runs the risk that the financial institution will collapse or steal her funds. Hyperinflation can effectively do the same thing. With credit, the danger is that bad luck or bad judgment
will lead the borrower into repayment difficulties. Then the temptation will be to borrow even more—to
take new loans to pay old ones. Whatever mechanisms the lender uses to enforce collection—public
shaming, peer pressure, the proverbial damage to kneecaps—then come to bear.
51
The average effect reported here is for those receiving the offer, not those taking it. The group receiving the offer is randomly defined, and is the basis for meaningful comparisons. People in the subgroup taking the offer are self-selected and
might have saved more anyway. “Tension” refers to the time consistency, or hyperbolic discounting, the researchers found.
Asked to choose between hypothetically receiving 200 pesos today or 300 a month later, and then between 200 in 6 months
or 300 seven months from now, those women offering conflicting answers—200 when the choice was today, 300 when it was
deferred—were more likely to join than other women, and than men generally.
52
sharemicrofin.com/services.html, viewed October 20, 2010. The insurance is underwritten by the U.S. group MicroEnsure.
53
Duflo et al. (2008). “Expensive” means costing more than 300 rupees. The average reported cost for such episodes was Rs
1,900, which is more than twice the average per-capita consumption in the sample, Rs 708.
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The differences in risk show up as differences in cost. Financial service providers are generally
seen as better risks than individual clients. That means that you must pay more to your bank for trusting
you (in lending to you) than you must pay when trusting the bank (in saving with it). In Vijayawada, for
instance, despite the modest appearance of the 15 percent up-front charge, Ramalu’s moneylender
charges far more than Jyothi does for taking savings. After subtracting the Rs 150 fee, Ramalu’s initial
balance is Rs 850. He starts repaying immediately so that his average balance over the 10 weeks is half
the Rs 850, or Rs 425, of which the Rs 150 is 35 percent. A rate of 35 percent for 10 weeks works out to
182 percent per year and a stunning 382 percent with compounding, more than ten times Jyothi’s rate.
Why then has the microfinance been led and dominated by one service, and an expensive one at
that, namely microcredit? One reason is that regulators are more willing to let start-up non-profit groups
place funds with the poor than vice versa. Only institutions meeting certain standards—banks—should
be entrusted with other people’s money. This is a good reason. But notice that it does not imply that
credit is ideally better for the poor than savings and insurance. Thus, various financial services can substitute for one another, in practice they do so partially and imperfectly. That means that poor people often use financial services in ways that are not ideal. That a loan is taken in practice does not mean that a
loan is best in principle.
Conclusion
This review of the role of financial services in daily life and economic development generates a series of
cautions for those who see microfinance—microcredit in particular—as an eliminator of poverty. The
poor need financial services for many things in addition to enterprise. Credit can serve many needs, but
savings and insurance serve many needs more effectively when available. Microentrerprise is more
about surviving poverty than escaping it. Thomas Dichter, a long-time practitioner and evaluator of microfinance, observes that no country that is rich today got that way through tiny loans for tiny enterpris-
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es.54 Indeed, every comparison between rich and poor countries, as between poor and middle-class people within poor countries, drives us to conclusion that in the broad, economic development is synonymous with reduction in microenterprise and growth in employment due largely to the expansion of formal enterprises backed by more conventional finance.
All this suggests that next to the extraordinary poverty-reducing power of the industrial revolution, microfinance is a palliative. Does that mean that the value of microfinance is sometimes exaggerated? Probably. Does that make it wasted charity? Not necessarily. The poor need financial services at
least as much as the rich. For people navigating the unpredictable and unforgiving terrain of poverty,
any additional room for maneuver, any additional control, can be extremely valuable. As Jonathan Morduch, a New York University economist and thoughtful observer of microfinance, told a writer for the
New Yorker, “That is a valid critique, to a point. But get real. How long are you willing to wait for the
revolution? I can’t see any moral foundation for not trying to address the current deprivations of the
world’s poorest billions. If microfinance can help provide options in cost-effective ways, we should celebrate it.”55
54
55
Dichter (2007).
Bruck (2006).
25