Archive for June, 2006

The White Man’s Burden book review

June 24th, 2006

The White Man’s Burden: Why the West’s efforts to aid the rest have done so much ill and so little good

by William Easterly

Boy, has this book started a lot of controversy in the international aid community. You’ve even got Nicholas Kristoff writing an oped piece in the New York Times in response to his book! Easterly, a Professor of Economics at NYU and previously an “insider” at the World Bank, doesn’t pull any punches in asking the hard questions about the results of international aid. He’s an economist, so his book is full of numbers and statistics supplemented with a number of humanizing stories.

In a nutshell, he asks “After $2.3 trillion over 5 decades, why are the desperate needs of the world’s poor still so tragically unmet? Isn’t it finally time for an end to the impunity of foreign aid?” He points out that despite spending all of this money, we still don’t deliver vaccines and other medicines costing < $1 and insecticide-treated mosquito nets at a few dollars to those who need them and die without them. The main issue, he argues, is that our international aid agencies (he focuses mostly on multilateral and bilateral government orgs including USAID, The World Bank and the International Money Fund) are run by planners, not the entrepreneurial, finding-what-works “searchers”. We in the West are very utopian with a grand plan to eliminate poverty always the goal and what the politicians like to talk about.

The Big Push Strategy has no Basis in History

Easterly’s argues through his research data that the following legends persist and drive much of the “Big Push” thinking behind international aid strategy today:

  • Legend #1: The poorest countries are stuck in a poverty trap from which they cannot emerge without an aid-financed big push.
  • Legend #2: Whenever poor countries have lousy growth, it is because of a poverty trap rather than bad government.
  • Legend #3: Foreign aid gives a big push to countries to achieve a takeoff into self-sustained growth.

These “legends” are core premise for the “spend more on aid” supported by Jeff Sachs and others. Easterly questions the existence of this poverty trap concept as there have been many success stories of countries growing wealthy without significant aid (e.g. East Asian Tigers including Hong Kong, Singapore, Taiwan and South Korea). A few notes

  • May 2005 study that “found no evidence that either ‘short-term impact aid’ or any other type of aid had a positive effect on [a country's] growth.” (p. 49)
  • “Over 1950-2001, countries with below-average aid had the same growth rate as countries with above-average foreign aid. Poor countries without aid had no trouble having positive growth.” (p. 39)
  • Another new study found that as aid represented 8% or more of the GNP of a country that the there was a negative effect on growth. (p. 50) He notes that 27 countries are already about the 8% aid level and that if the Big Push strategy continues that virtually all of the low-income countries will be pushed over the 8% level.
  • In reality, he notes that “most countries that escaped from extreme poverty did so with gradually accelerating growth.” (p. 51)

Some additional highlights from the book (I’m skipping a lot of other interesting stuff):

  • Government-to-Government Aid. He asks the question why our government aid agencies need to always give to directly to often corrupt other governments rather than through other orgs who could get the money to the intended people/projects.
  • Planning Markets? An oxymoron? Why so often do we in the West think that we can go in and impose significant market changes on the Rest and expect them to endure and succeed? This isn’t how it works (or has worked) in the West?
  • Political Correctness vs. Truth. Easterly highlights many examples where the IMF and the World Bank have continued to poor money into countries where there was blatant and widespread corruption with their previous capital. They need to call a spade a spade rather than deceiving themselves that somehow a miracle change will happen this time.
  • Helping Bad Governments will Make Them Good Governments? Easterly notes that this is a common argument to justify giving money to gangster governments arguing that it will promote their political development and reform. He responds “this argument is based on the overambitious goals of political transformation [which have no historical precedents].” (p. 157)
  • No Aid Org is Accountable. Since the multiple international aid organizations have very broad and overlapping (and sometime contradictory) goals/agendas, they can simply throw up their hands when they don’t produce results and blame it on the other guy. That’s why you always hear them take about “inputs”, not “outputs” (results). Easterly argues for scaling back aid agencies to focus/specialize on smaller, specific, measurable projects which they are held accountable for by independent evaluators and the receipients of the aid. Amazingly, this almost never happens today.
  • HIV/AID drugs. He explains that it costs $1,500 per year of total cost to administer the latest cocktail of HIV/AID anti-viral drugs even if the meds themselves are basically free. On average, people taking these drugs live an extra 3-4 years. He asks the question … have we ever asked the Africans how they’d recommend we spend the $5B we’ve committed to these treatments? Would they spend it all in this way? He has asked many Africans and they would likely spend very little of the $5B on this healthcare and instead spend it on other much broader impact healthcare initiatives which would save way more lives. Hmmm … interesting.

International Aid Needs Massive Reform

So, is Easterly against international aid? Surprisingly, not. He argues for significant reforms to focus on what works, smaller initiatives (vs. grand plans) and more accountability. So, his grand plan is that there is no grand plan. History argues that it is the initiative of the people themselves along with their governments are the only path to sustainable economic growth. In conclusion, Easterly summarizes:

“Aid won’t make poverty history, which Western aid efforts cannot possibly do. Only the self-reliant efforts of poor people and poor societies themselves can end poverty, borrowing ideas and institutions from the West when it suits them to do so. But aid that concentrates on feasible tasks will alleviate the sufferings of many desperate people in the meantime. Isn’t that enough?”

Scary for the status quo in international aid, but great news for the customer!

Read my full book review

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Posted in Poverty Reading List

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Implications of For-Profit Microfinance

June 21st, 2006

Recently, I wrote about the advantages of for-profit microfinance and why I believe that having this governance structure resulted in more poor people being served and served better in the long-run.

I want to highlight some of the implications of for-profit microfinance for donors and investors as there always are implications to whatever path you take. It is important to take a reality-based view of what is likely to happen so our expectations are properly set upfront.

1. Impact studies aren’t valued. For-profit microfinance institutions (MFIs) don’t make impact analysis (e.g. how much am I really helping my customers improve their lives) a high priority. MFIs are focused on growing their client base and maintaining their relationships with existing clients — all while earning a return for shareholders. Implication: as a social donor/investor, you may not get a lot of impact reports.

2. Customers are at the center. Successful for-profit MFIs are going to be very customer centric. Finance services is a service industry. If you are not serving your customers, someone else will. Market research becomes very important … what do our target customers want/need? You can’t have condescending attitudes to your clients (MFIs, pay attention to this!) … as they will migrate to your competitors who treat them with more respect. Implication: employees, shareholders, donors and other stakeholders are not #1 and although important need to realize their priority.

3. Some people will get rich. If for-profit MFIs are successful, some of the major shareholders (which often include the management team and investors) will earn a windfall return — possibly becoming millionaires. Many of these organizations were first started as non-profits and were donor funded. The shareholder value is being created from profits made from offering financial services to the poor. Implication: Investing in MFIs is a “package deal” … you are betting on your money being highly leveraged in sustainably helping a lot of people out of poverty and there will be shareholders who participate in the value being created.

4. Many MFIs will and should disappear. The reality is that when there is a huge gap between demand and supply that there are lots of opportunities for many MFIs to open shop. The barriers to entry for a new MFI are very low in the current market. When the market for microfinance services becomes more saturated, there will naturally be significant industry consolidation. The least efficient/strong MFIs will either be bought, get out of the business or go out of business. Implication: You may invest in a MFI which fails or gets absorbed into another MFI down the road. If you want to be more diversified, then you’ll want to invest through an intermediary (like Unitus) which will spread your investment across multiple MFIs.

5. For-profit MFIs need professional management. Operating a MFI when you have to do almost no marketing (customers basically line up for your products), you have no competition and donors/investors continue to fund your losses for the sake of growth is not sustainable. MFIs need to build an institution which can endure the inevitable crises and become a high-efficiency (using low cost) supplier. This requires management talent which knows how to operate a growing business and to manage the expectations of the various stakeholders — investors, employees, business partners, auditors, government regulators, politicians, etc. Implication: Look for for-profit MFIs to build a strong senior management team beyond their initial entrepreneurial team.

What are some other implications of for-profit MFIs? Please post as comments.

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Posted in Microfinance

Achieving Sustainable Poverty Reduction

June 13th, 2006

The core mission of the microfinance movement is to contribute to a material decrease in global poverty by providing helpful financial services to the world’s poor currently not served by the mainstream financial sector. That is, to help the poor become the non-poor. The assumption is that quality microfinance services are enabling the poor to earn their way out of poverty. The outreach results tracked by organizations like Microcredit Summit are very encouraging with an expectation that the cumulative client base of microfinance institutions (MFIs) was around 100 million in 2005. Grameen Foundation USA recently released a comprehensive review of the various impact studies on microfinance which overall indicates positive trends.

I’d like to propose that the goal of poverty reduction is to attain sustainable poverty reduction. I’d like to define sustainable with a high bar – that is, that a non-poor person/family is not easily pressed back into poverty due to a crisis event including death/illness in family, natural disaster, bad weather, economic turbulence, crime, etc. While I view this as a high bar – I think it is an appropriate high bar to strive for. The reality is crises do happen in everyone’s normal life so to have a plan that ignores them is not a plan. If all we’re doing is helping a poor person become temporarily non-poor, then I question whether what we’re achieving is much better than most hand-out aid programs (with the possible exception of being a higher-efficiency approach.)

I’ve noticed that the terms “microfinance” and “microcredit” are often used interchangeably with the latter term more popularly recognized as result of programs like the UN’s 2005 Year of Microcredit. I view microcredit as one of the components of the larger microfinance concept which represents a possibility of a wide range of financial services designed and optimized for the unbanked poor. To date microcredit has been the prevalent microfinancial service offered to the poor and for good reason … there is immediate demand from the poor for loans.

What is needed in order to sustainably lift and keep the poor out of poverty? I believe that that there are three core steps which must be made available in a highly scalable and efficient way:

  1. an opportunity for the poor to generate more income using skills they already have or can easily develop in a self-service manner;
  2. a safety net so that crises do not result in return to poverty
  3. hope that their children will have even better opportunities to participate in the global economic system

The first objective to break the poverty cycle is to enable stabilization by enabling the poor to generate more income. If there isn’t more income, then everything is a crisis and there are few options for the family to begin focusing on longer-term benefits and activities. This is why productive microcredit – loans directed to business activities not consumption activities – are often the most effective jumpstart tool. Once income is starting to increase, there is the need for a safety net to protect the assets of the family. There are many needs here including various insurance and savings products which provide a buffer/cushion from the impact of crises. Finally, an important third step is that the poor (maybe now non-poor) adults have hope for the generational cycles of oppressive poverty to be broken. While many of these formerly poor adults will likely not become wealthy or achieve even middle income, they can start to see the opportunity for their children to climb even further towards a better future in a global economy.

I think the microfinance movement is overwhelmingly focused on the microcredit front (what I call the microcredit ghetto) and needs to start making more investments immediately in safety net microfinance products. See The Microinsurance Centre web site for some good resources. Finally, I think the microfinance movement will need a strategy for connecting their local clients with the global economy. This is going to need some more creative thinking.

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Posted in Opinion

Why Equity Matters to Microfinance

June 13th, 2006

In a previous post on for-profit microfinance, I summarized some of the benefits that I see for the poor in the trend for microfinance institutions (MFIs) to become for-profit entities rather than the traditional non-profit entity model. One of the key aspects of a for-profit entity is the ability to sell ownership shares to investors to raise capital.

I caught up (via email) with Geoff Woolley, a very experienced venture capitalist (Dominion Ventures, European Venture Partners, MACC Private Equity and more) and an early pioneer in microfinance equity. Geoff currently chairs the Capital Markets Committee on the board of Unitus, an innovative global microfinance accelerator. He was very involved in setting up the Unitus Equity Fund … one of the first private-money-only private equity funds exclusively focused on investing in start-up MFIs.

Dave: Geoff, first, what is your background related to investing equity capital in companies?

Geoff: I have been a venture capitalist all my professional career and founded both a US and European private equity firm. Through myself and my firms, I have invested in hundreds of growth companies … both start ups and expansion stage companies.

Dave: What experience have you had in making equity investments in MFIs?

Geoff: Investing direct equity rather than making grants or giving loans to MFI’s is relatively new. My experience has been over the last few years with assisting in structuring the financing of the Unitus partners. With the new Unitus Equity Fund, we work exactly as most private equity firms. My “non profit job” and my regular job are almost alike except with Unitus I know my efforts help thousands of poor women and their families in a small way.

Dave: It seems like there is still a lot of confusion about why MFIs need equity investments. Why not just give them donations/grants or give them loans?

Geoff: The key word is sustainability. Essentially, if an MFI does not learn to become profitable, most donors will grow tired over time of supporting their financial needs. The best way to think about MFI’s are as small start up banks. If a wealthy bank founder provided all initial capital and continues to support the bank without taking equity or a loan note, potential new lenders or investors would not be able to assess the banks profitability or sustainability. This “free capital” would never appear on financial statements. By treating an MFI like most start up companies, lenders and new investors will more easily understand the MFI and its progress. With MFI’s, profitability is a measure of effectiveness rather than strictly making money. Capitalism and social purpose are well aligned.

Dave: How do MFIs grow their equity base?

Geoff: The same way as banks do. They raise more equity (by issuing and selling shares) or reinvest profits from their operations. In MFI’s that are licensed to collect savings from clients, these saving accounts help increase the MFI’s capital base which enables it to borrow less from outside lenders.

Dave: There is talk about some MFIs reaching the limit of how much they can borrow. What are those limits and how does equity impact lifting those limits?

Geoff: Reaching borrowing limits could relate to either market saturation or an inadequate capital base. In most microfinance markets, the need of the poor for capital is far from saturated. I hope someday to see the “problem” of oversupply of capital for the poor since it means poverty will be reduced significantly. Most MFI’s reach limits based upon their equity or capital base. Both banking regulators and an MFI’s lenders set limits in terms of the amount of debt that a MFI can have outstanding in proportion to the amount of equity they have built up on their balance sheet. For example, if an MFI wanted to borrow $5,000,000 from a state bank to make its small $100 loans, the lending bank might require $20 of equity for every $100 of loan it will provide to the MFI. This would be a 5-to-1 capital base requirement and the MFI would need $1,000,000 in equity or capital to borrow the requested $5,000,000. With many MFI’s expanding their number of borrowers by more than 100% per year, more borrowing and proportionate equity is required.

Dave: What are some of the additional benefits to MFIs of having equity infusions?
Geoff: The most important positive factor for a MFI is independence and being the masters of their own destiny. Management can plan for the future without outside factors such a grants being cut or reduced. Being able to plan and understand your resources is key to the success of any growth companies including MFIs.

Dave: Are there any downsides to MFIs in taking outside equity capital?

Geoff: Even in the US, we practice a “modified” capitalist economy where regulators, investors, voters and many other constituents impact and constrain the market system. Similar “guardrails” are required in microfinance to ensure it keeps its focus on the unbanked sector. Social guidelines and priorities need to be prioritized against pure profit decisions. For example, the cost to transact a $100 loan versus a $500 loan is the nearly the same. Therefore, a MFI could become more profitable if it moved to making $500 loans to increase profits. In such a case, the social benefit of making loans to the poorest women should be prioritized before maximizing profits. For instance, these social safeguards are outlined and documented in Unitus Equity Fund’s equity investments to ensure MFI management keeps their focus on the targeted unbanked poor. A balanced approach of social good and sustainable operations is key to the Unitus mission.

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Posted in Microfinance, Social Business