Book Review: Due Diligence: An Impertinent Enquiry into Microfinance

It has been said that microfinance — tiny loans given out to the poor to allow them to establish an income-generating activity — is the one development policy that the average person in the street will have heard of and, moreover, might actually wish to individually support. Famously brought to the world’s attention in the 1980s by the U.S. trained Bangladeshi economist and 2006 Nobel Peace Prize winner, Dr. Muhammad Yunus, and then decisively driven forward by the World Bank and the U.S. government through its USAID aid assistance arm, microfinance soon became the highest profile and most generously funded international development policy. Neoclassical economists and neoliberal policymakers were quite beside themselves at the news that self-help and the individual entrepreneurship activities of the poor appeared to be driving forward a major historical episode of global poverty reduction and “bottom-up” economic and social development.

Many people around the world will therefore have been deeply disappointed by the recent outpouring of bad news about microfinance: market meltdowns caused by over-indebtedness, aggressive loan collection practises, client abuse, possible suicides, and some spectacularly egregious profiteering by institutions and individuals involved in providing microfinance. ¹ Worse, in 2011 a major UK government-funded independent systematic review dramatically concluded that there was simply no evidence to confirm that microfinance has had an overall positive impact on the lives of the poor this last thirty years, arguing that the time and resources expended on the microfinance movement might perhaps have been much better used elsewhere. ² It is no exaggeration to say that the entire microfinance industry is today under an existential threat.

Into this maelstrom steps David Roodman, a senior researcher at the Center for Global Development (CGD) in Washington, DC, with his new book Due Diligence: An Impertinent Enquiry into Microfinance. Written with the help of his Microfinance Book Blog, which allowed for comment, corrections, and suggestions to emerge at each stage of the book, and sponsored by the MasterCard Foundation and the World Bank’s Consultative Group to Assist the Poor (CGAP), on publication Roodman’s book attracted very high praise indeed (including from Muhammad Yunus himself). However, Roodman was widely reported in the media on account of his pre-release statement that “[o]n current evidence, the best estimate of the average impact of microcredit on poverty is zero,” ³ so I was genuinely intrigued by the high praise coming from the microfinance industry. Surely, I thought, microfinance supporters would be angry to hear that Roodman now thinks microfinance does not actually work? On reading Roodman’s book, however, it becomes perfectly clear right away why such lavish praise was forthcoming. His book is not an independent and objective analysis of microfinance, as might have been hoped for. It is instead a deeply political-ideological book, one that consistently and very deliberately misinterprets reality and distorts evidence in order to try to affirm — as presumably intended by all parties concerned in the promotion, financing, and support of his book — the overall usefulness and contribution to humanity made by the microfinance industry. Let me highlight just a selection of the very many serious flaws to be found in the book.

After an interesting but contentious historical survey, ⁴ the problems really begin on page 67, where Roodman describes CGAP — as noted, one of the main sponsors of the book — as a “microfinance research body,” and in subsequent pages he quotes approvingly from many of its publications. As anyone familiar with the microfinance industry knows perfectly well, however, CGAP is actually anything other than “just” a “microfinance research body.” Established in 1995 by the World Bank, housed at the World Bank, and still under the World Bank’s effective direction, CGAP was founded with the clear aim that it would be a pivotal advocate for microfinance, and it was given specific responsibility to go to bat for the commercialized (“neoliberalized”) version of microfinance. It is wrong for Roodman to portray CGAP to the reader as some sort of independent “microfinance research body” when it is no such thing. It is a little like saying that the old Research Department attached to the Central Committee of the Communist Party of the USSR was “just” a “research body.”

Further distortions of reality follow when Roodman discusses the key issue of why commercialized microfinance was so urgently needed. Here Roodman deliberately restricts his reading on rural finance to just a handful of the most ideologically-driven USAID-sponsored outputs from the early 1980s, work that he will have known was precisely designed to organize and filter the then experience in just such a way as to come to the required market fundamentalist conclusion. So it is no surprise when Roodman, too, is led to conclude (72) that, “[s]ubsidised credit had just one problem: it didn’t work.” This is utter nonsense. A genuine reading of the history of rural finance actually shows that all of the most successful agricultural sectors in recent times quite centrally deployed various forms of subsidized rural finance. Sure, not all individual subsidized credit schemes have been successful. And most accept that governance problems are often a significant problem in subsidized programs, especially in states with minimal bureaucratic capacity. But the central experience of subsidized rural finance is not actually one of failure, but of meaningful long-term success. This point is adequately demonstrated not least by the positive experience of the United States after 1933 with the Farm Credit Act, but also in postwar Europe (especially in Scandinavia) with its commendable achievement of food security and rural stability quite soon after 1945, and then in East Asia from the 1960s onwards thanks to the spectacular rural development and poverty reduction successes registered by South Korea, Taiwan, China, and then, finally, Vietnam. As Chang concludes his important historical review of agricultural systems for the FAO, ⁵ “subsidized credit does not guarantee agricultural success. However, agricultural success without it is impossible to achieve.” A sweeping evidence-based narrative of broad success with subsidized finance is thus deliberately ignored by Roodman in favor of a narrow, artificially constructed, and largely false, but ideologically far more serviceable, narrative of failure.

Moving to chapter 6 (172), we come to Roodman’s brave concession that after thirty years of the microfinance movement “there is no convincing evidence that microcredit raises incomes on average.” But rather than accepting defeat, Roodman immediately signs on to the idea of “financial inclusion.” This is actually the neat “goal rotation” trick currently being deployed within the microfinance industry in order to save itself from obsolescence in the light of all the damning evidence mounting against it. However, Roodman presents himself with a major problem here. This is because there is simply no solid evidence to show that “financial inclusion” has had, or could have, an important impact on the poor when compared to other interventions using the same funding and targeted at the same people in poverty. Indeed, the arguments made in favor of “financial inclusion” are often no more than mere anecdotes, as when Roodman argues that because we in the richer countries value our check books, our bank accounts, and our overdrafts, this must mean we should urgently seek to provide such items to the poor in developing countries. And thus we see what used to be hailed as a “locally-developed” Third-World solution for poverty revealed for what it actually is: a reflection of our own obsession with credit and finance. Roodman’s argument lacks any shred of evidence that a development policy extending such services to the poor in developing countries will justify the cost against the likely benefits forthcoming, still less the opportunity cost in the form of other interventions (health, education, infrastructure, small business development, etc.) not undertaken. It is surely no coincidence that the main global driver behind the idea of “financial inclusion” is none other than CGAP. ⁶

In chapter 7 Roodman describes the microfinance industry as “fundamentally freedom enhancing.” Most would agree that financial services can be freedom-enhancing. In the case of the contemporary microfinance movement there is just so much more evidence to show that providing such services to the point of ubiquity has quite significantly denied and degraded individual freedom. Just ask those struggling to cope in the many indebted communities in Bolivia in the early 2000s, more recently in Morocco, in Bosnia, and in Andhra Pradesh state in India, and also in Mexico, Cambodia, Peru, Georgia, and other microfinance “saturated” countries. The freedom to go into debt is by no means always a free choice reflecting careful thought. Like gambling, the psychology of over-indebtedness in poor communities is complex and all too often suggests irrational motives or compulsion on the part of the poor, since the poor are adversely affected into the longer term. This demands an explanation. But Roodman chooses to ignore the reasons why dramatically rising and ultimately freedom-restricting levels of individual indebtedness are occurring in precisely the poorest communities most penetrated by the microfinance movement.

In chapter 8, we come to what Roodman claims (223) is the “brightest spot” in the book’s assessment of microfinance. This is his idea that the microfinance sector is engaged “in building dynamic institutions and industries,” a development that helps to provide new institutions and so lots more finance-related services to the poor than they have ever had. This institutional innovation aspect, he claims, provides more than enough justification for the continued existence of microfinance. This is a quite absurd argument to make. Without fully taking into account what an institution has actually achieved in the community, one simply cannot fall back to argue that the mere existence of that institution itself is a positive outcome. Even long-standing microfinance supporters appear to accept this, such as Dean Karlan in his recent book with Jacob Appel, who argues that “microcredit is the means to the end, not the end itself,” and that “the tool is not what matters; reducing poverty is.” ⁷ More importantly, institutional theorists from Marx right through to conservative theorist and 1993 Nobel Economics Laureate Douglass North have shown that “bad” institutions very often arise from such institutional innovation processes, and that these “bad” institutions are sustained by the powerful even though they are known to be impeding the economic and social development of society. And, indeed, the evidence to date pretty conclusively shows that just such a set of “bad” institutions has evolved to increasingly dominate the microfinance sector ⁸ ; perhaps most notoriously so in the case of SKS in India and Banco Compartamos in Mexico. ⁹ Roodman’s “institutional innovation” idea simply does not hold water.

I give Roodman credit for having authored a well-written book which contains fascinating and entertaining excursions into financial history and into the financial lives of the poor. In addition, Roodman does put forward rather nicely some of the possible benefits forthcoming for the lucky few micro-entrepreneurs who succeed thanks to the provision of microfinance. Overall, however, the book is fundamentally flawed. Roodman has provided to order a largely spurious raft of justifications that, in spite of its acknowledged zero impact on poverty, might nevertheless underpin the continued activities and existence of the increasingly discredited microfinance industry. The book is thus less a product of genuine research and more a bought-and-paid-for, but yet sophisticated and subtle, piece of propaganda. I do wonder how much evidence it would take for Roodman to write a book that is not a foregone conclusion that microfinance is working, even when we know that it does not.

Milford Bateman. Visiting Professor of EconomicsDepartment of Tourism and EconomicsUniversity of Juraj Dobrila at PulaPula, Croatia E-mail: milfordbateman@yahoo.com