Microfinance and the entrepreneurship revolution that wasn’t
Last week we wrote about CGAP’s new “impact narrative for financial inclusion”, which no longer makes entrepreneurship and business development the primary rationale for expanding access to financial services. This week, we explore why they made such a dramatic change.
CGAP’s change of heart may have been inevitable. While the various technologies that have been used to expand financial inclusion––group guarantees, social collateral, digital payments platforms, and agent networks––have indeed proven to be very effective in expanding low-income people’s access to formal financial services, they have not led to an entrepreneurship revolution. Few microfinance clients transform from subsistence livelihoods to more secure and sustainable enterprises.
Evidence for the failure of the entrepreneurship paradigm has been accumulating for years. The limited impact that financial inclusion has had on the businesses and incomes of individual entrepreneurs has led some to indict financial service providers themselves. They have been accused of charging excessive interest rates, over-lending, and foreclosing on assets, thereby leaving their low-income clients even poorer than before.
There is no doubt that there have been abuses, but the fact that the vast majority of clients repay their loans on time and borrow again indicates that these problems are not widespread and systemic enough to be the main explanation for the failure of an entrepreneurship revolution to materialize.
ACCESS’s view is that it was always wildly optimistic to expect that small-scale, undercapitalized, inefficient producers with limited information can extract profit from market transactions in which they have no power. The belief that markets are “free”––that there are no power imbalances and that information is available to all––was ideology, not economics. Because they lack market power, the fact is that most people with micro-enterprises get by rather than get ahead.
The prototypical microfinance client is often described as an entrepreneur, but their characteristics as well as their activities are nothing like the entrepreneurs who are increasingly revered in developed economies. They are neither seeking to introduce new products or services to the market nor “disrupt” incumbent models, much less pursue some form of personal development. With barely enough resources on which to live, their entrepreneurial efforts are motivated primarily by survival. What they do can be more accurately called “livelihoods” or subsistence enterprises.
Operating with limited skills and small sums of start-up capital, these smallholder farmers and micro-entrepreneurs often sell goods and services to customers who, like themselves, are at the base of the income pyramid. Their small scale, coupled with a lack of competitive advantage, make it extremely challenging for them to grow their businesses or even expand their profit margins beyond the subsistence level.
In upcoming posts, we’ll explore further the characteristics of the subsistence entrepreneurs that constitute most microfinance clients and contrast them with transformative entrepreneurs who have successfully commercialized their businesses. These microfinance “success stories” are not just useful for marketing. They are a population to learn from. ACCESS has studied them to understand what common factors contribute to business success and whether those factors can be transferred to others in order to increase the impact of financial inclusion.