An outstanding investigation of the realities behind microfinance

It is impertinent to question the effectiveness of charitable efforts, and this makes it difficult for anyone to raise doubts about the practice of microcredit, which involves lending small sums of money to the poor at high interest rates. But if the purpose of the charitable efforts is to help the poor, rather than to gratify the donors, then someone really does need to investigate whether the practice actually works. That person is David Roodman in his book Due Diligence: An Impertinent Inquiry into Microfinance.

The quick – and for most donors very disappointing – answer is that there is no convincing evidence that microcredit is an effective tool for bringing people out of poverty. There are many stories of people who have indeed worked their way out of poverty after accessing microcredit loans, but there are also many stories of people who have worked their way further into debt. According to the author, the most reliable research into the effectiveness of microcredit does not indicate any net positive effect on the incidence of poverty. Microfinance as a whole, however, particularly microsavings accounts, does provide a very useful means for the poor to manage their money.

Intuitively these findings make sense. In Western countries, poor people who save money tend to improve their lot, whereas poor people who max out their credit cards tend to stay poor. Poor people tend to borrow money more often to meet today’s needs than to invest in high-return business enterprises. Finding food for today is a more pressing concern than repaying a loan tomorrow.

The surprising thing about the findings is that they tend to contradict the virtually unanimous voice of microcredit proponents over many years. Presumably the microcredit myth has lasted so long because it appeals to our paternalistic instincts as donors, romantically portraying the poorest of the poor as skilled entrepreneurs just needing access to capital (when what they really need is opportunities for decent employment), portraying women as better managers of money than men (when in reality they are perhaps more susceptible to coercive demands for repayment), and suggesting that poverty can be solved through a simple commercial transaction (when much more complex structural change is required).

The author does not confine himself to investigating the effect of microfinance on financial poverty. He also considers the impact on freedom and industry building. He presents his observations in a measured and impartial but very engaging and readable manner. I highly recommend the book to anyone who is concerned about serving the poor effectively.