The original rationale for expanding financial inclusion was that access to formal financial services enables low-income self-employed entrepreneurs and farmers to take advantage of market opportunities. Doing so was supposed to make it possible for them to expand their businesses, increasing their own incomes and creating employment for others.
Yet in fact the architects of modern microfinance warned about the futility of linking credit and other financial services to specific outcomes such as business growth or increased income of clients. In his 1991 book that launched the modern microfinance movement (“Finance at the Frontier – Debt Capacity and the Role of Credit in the Private Economy”), Dr. John von Pischke of the World Bank noted the fundamental difference between a loan in cash and other productive assets such as land and equipment. Those assets could only be used for one purpose; a machine, for example, is not a substitute for food. But money borrowed to purchase a machine could be used to buy food––and actually is used that way if there is not enough income or savings that day to put food on the table. If income earned tomorrow is used to buy the machine, did the loan pay for the food or the machine?
Von Pischke called this phenomenon the “fungibility” of money. A client has both multiple sources for accessing money, not just the loan, as well as multiple needs for the money. Credit is only an enabler, adding to purchasing power. What matters is not the source of money, but how it is used. As a result, he concluded, “it [is] impossible to identify unequivocally the returns to borrowers from credit”.
Although fungibility is indeed real, what von Pischke left unexplained was why borrowers would use loans for purposes other than investing more in their farm or business if that was the route through which they could enjoy a permanent increase in income.
ACCESS’s view is that the original impact narrative for microfinance was based on a false understanding of entrepreneurship. The fact is that most microfinance clients run subsistence livelihoods rather than true enterprises. They rely heavily on their social networks for survival. The personal nature of economic activity at the subsistence level ensures repeat sales, which contributes to the survival of the business.
However, while relationships with vendors, customers, and family members help the entrepreneur run a viable business at an everyday level, their closed nature means that the economic system and most livelihood activities that are embedded in it are often static. Ideas are copied from others operating in the same environment, leading to the proliferation of low-margin businesses. In addition, the markets in which these livelihood activities operate are limited and too poor to support products and services sold at a premium; even if a micro-entrepreneur could find a way to differentiate their offer, they have no way to protect that advantage from competitors.
With no discernible competitive advantage, for most microfinance clients running subsistence livelihoods, the barriers to growth are almost insurmountable. This is why microfinance clients use loans for working capital but rarely invest in expanding or diversifying their businesses. This is why the hoped-for entrepreneurial revolution never occurred, and why impact studies find little link between access to finance and income growth.
Yet some financial inclusion beneficiaries do experience a transformative change from subsistence livelihoods. Blurbs about successful microfinance clients are a mainstay of the industry’s promotional materials, but rarely have they been systematically studied to understand what, if any, common factors contributed to business success.
To address this gap, ACCESS Advisory has recently completed a study of successful women entrepreneurs in Vietnam and the Philippines. The research was intended to shed light on the knowledge, attitudes, skills, and habits that characterize successful micro-entrepreneurs to determine what, if any, success factors can be replicated in order to make financial inclusion systematically more impactful.
We’ll share more of our findings in our next blog post.