Pete Sparreboom, a Europe-based researcher and consultant, has written me privately to ask what we should make of the apparent failure of microfinance to lift most of its clients out of poverty. She has consented to let me post her remarks here. I follow with my tentative answer, a post I did for MicroLINKS as follow-up to last week’s USAID Speakers Corner online discussion. First, here is what Pete Sparreboom wrote to me:
Thank you for the very systematic review and analysis of what we know about the impact of microfinance. So maybe microfinance helps the poor smooth their income and mitigate risks, and maybe we can develop products that do this even better. But is this sufficient? I think many of us did not get into microfinance merely to help the poor cope with their situation; the point was to help them escape from poverty!
A fundamental assumption behind microfinance has been that the poor can work themselves out of poverty through smallholder farming or non-agricultural microenterprise. But what if this assumption is fundamentally wrong? You mentioned that the return on microenterprise is seldom high enough to generate major increase in household income and expenditure; the same goes for smallholder farming. Very few microenterprises actually experience significant growth. You also mentioned that many of the poor would really prefer to have a salaried job.
If we really care about poverty reduction, shouldn’t we be investing more of our energy in related interventions that do increase income? For example, shouldn’t we work harder to develop viable products for small and medium-sized enterprises and farms with the potential to grow and create decent jobs for the majority of the poor?
Here below is both my answer to Pete and the text of the post I did for the MicroLINKS blog:
Microfinance as a Bridge to Inclusive Markets for Subsistence Farmers
In the MPEP Speakers Corner on “Strengthening Smallholder Resilience through Inclusive Markets” (February 26-28), we had to confront the reality that the great majority of smallholder households have too few assets (land, knowledge, tools, inputs, etc.) to participate in agricultural value chains. They are non-commercial, subsistence farmers. They have little income; a relatively high proportion comes from wage labor and non-farm microenterprise. They are vulnerable to unpredictable fluctuations of income, and therefore consumption, and to health and other shocks. Their resilience in the face of these shocks is weak.
It seems that resilience must be strengthened as a pre-condition for these subsistence households to engage with local value chain development. This means stabilizing income and building assets (physical, financial, human and social), which together enable the household to smooth consumption and cope with shocks. It seems microfinance can play an important role in strengthening resilience.
Subsistence households dovetail or mix whatever formal microfinance services are available with their traditional, informal financial management tools. On average, use of general-purpose microfinance seems to generate little additional household income. But it does have impacts in other areas. Recent randomized trials and other studies show that access to microcredit and microsaving services, even by themselves, can help poor households improve their resilience to shocks and better manage the daily stresses of poverty.
On the other hand, more specialized financing for purchases of inputs and tools that can increase agricultural productivity and incomes is generally neither accessible nor useful for subsistence farmers. How can the poorer smallholder farmers use general-purpose microfinance (from “small loan” providers, both formal and informal) to put in place the minimum they need to do business with the production-focused financial services (from “large loan” providers, be they banks, buyers or input suppliers)?
Here is an insight reinforced for me by the Speakers Corner discussion.
Poor households (any households) strongly prefer to expand the options available, as long as the new options do not foreclose old ones and do not impose unmanageable social, financial or legal obligations. Therefore, they are likely to maintain their engagement with their informal groups and networks for loans and savings opportunities, even while using more formal options as they become available.
Likewise, they maintain access to formal general-purpose microfinance services, even as they seek access to larger, longer-term borrowing and saving opportunities. This is a process of layering rather than replacing. Households seem to want multiple layers of options that offer reliability, flexibility, affordability, etc., which often mean trade-offs among these desired characteristics; hence the need for diversity of options as well.
General-purpose microfinance (informal and formal) serves to build assets that provide a store of resources to draw on in the face of shocks and financial stress. Given a respite from shocks, accumulation of these assets can also take the household to a higher level of security and enable access to services and wider support networks that may position the household to participate in more complex forms of financial services. This may include financial services from commercial banks or from buyers or from input suppliers or specialized value-chain investors, who can provide larger, longer-term loan capital and technical assistance that can make a real difference in smallholder agricultural productivity. Alternatively, this more solid base of assets may be used to secure capital to start or grow a non-farm enterprise. Or these assets could position one or more household members to get a job with a regular wage or salary. Why not all three options?
Human and social assets are as important as financial and physical assets for enabling a household to seize new opportunities in agriculture, enterprise and/or employment. There are financial products that can build or protect human assets, such as education loans, health insurance, health savings accounts, and general-purpose emergency loans. Group-based microfinance can both benefit from and further build social assets. Is that all financial service providers can do?
Freedom from Hunger and other practitioners have been showing for years that non-financial services can be provided, too. See www.ffhtechnical.org for lots of literature on this. Non-financial services can be delivered to clients either directly by the financial service staff or through linkages to specialized providers of health care and education, financial and business education, agricultural extension, literacy training and more. Direct provision of non-financial services challenges the management and financial capacity of the financial service provider, but so do linkage programs when done well. Fortunately, there is solid successful experience in doing it either way – and doing it in ways that are financially sustainable for the financial service provider.
In summary, general-purpose microfinance, as an effective tool for building resilience, also seems capable of helping subsistence farming households build bridges to market participation – assuming these markets are open to their participation through value chain development strategies that are inclusive of the poor.