Claims About Microfinance Unrealistic and Overstated

Mass Credit Is Not the Key to Economic Growth

February 15, 2007 • News Releases

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WASHINGTON – Microfinance is praised as one of the best methods for lifting the world’s poor out of poverty. But a new briefing paper from the Cato Institute casts doubt on those claims, and argues that micro‐​loans may not foster as much economic development and entrepreneurship as previously thought.

In the study released today, “A Second Look at Microfinance: The Sequence of Growth and Credit in Economic History,” author Thomas Dichter, a veteran of international development work since 1964, uses an historical approach to critique the practice, demonstrating that it does not noticeably affect economic growth or successful business development.

Microfinance, or the provision of financial services such as small loans to the world’s poor, aims to provide funds for investment in small businesses, thus spurring economic growth and reducing poverty. Yet Dichter distinguishes between subsistence activities and “real” business asserting that much microfinance is not, in fact, used for business purposes at all. “The average poor person in the past (and today) is not an entrepreneur, and when he or she has access to credit it is largely for consumption or cash flow smoothing,” Dichter writes. “The average entrepreneur prefers to start with informal credit or savings rather than formal credit.”

“Credit for the masses has been in the past (and is today) largely for and about consumption. Credit for real business is not for or about consumption, nor does it need to be accessible to everybody,” asserts Dichter. The history of economic development shows that growth comes first and then mass credit develops; and even then, the credit is for consumption, not investment.

“Economic development and its consequent massive poverty reduction did not depend on microcredit being made more accessible for income production or asset acquisition by the poor,” Dichter concludes. “Instead, it was the process of development that created jobs, which in turn made the working poor an attractive target for financial services, beginning with savings and then moving toward consumption so that the goods produced would have a wider market.”

Development Briefing Paper # 1