Development as a Nobel Cause Jayati Ghosh

There are many reasons to celebrate the award of the Nobel Peace Prize for 2006 jointly to Muhammad Yunus, the recognised creator of the “microcredit” model of finance for the poor that has swept across the developing world, and to the Grameen Bank in Bangladesh that he founded three decades ago. These reasons go well beyond appreciation of the valuable human qualities of the man himself, such as his creativity, persistence, charisma and passionate advocacy in promoting this model widely and extending it in various ways. The reasons for celebration also go beyond regional pride – as South Asians, or even as citizens of the developing world in general.

One important reason, of course, is that awards such as this rescue the Nobel Peace Prize both from the controversial dogfights that have accompanied some of the political choices of the past, and from being mired in a very restrictive notion of the concept of peace. This award, along with the earlier award to the African environmentalist Wangari Maathai, shows the Nobel Committee’s recognition that peace is not really possible without more equitable development.

The citation says as much, claiming that this prize is being given to Yunus and the Grameen Bank “for their efforts to create economic and social development from below. Lasting peace can not be achieved unless large population groups find ways in which to break out of poverty.”

But while this is clearly a much-deserved prize, it also exposes other weaknesses about Nobel Prizes in general. It is in some ways a safe, even predictable, choice. Rumours about this award have been in wide circulation for some time, given the now almost universal espousal of microcredit by the World Bank and international development agencies in general, as well as by many developing country governments. The UN declared 2005 to be “the international year of microcredit”, and there has been enthusiastic promotion in international circles by Bill Clinton and others.

Tit is worth noting is that the economist Dr. Muhammad Yunus received this prize for promoting peace, rather than the Nobel Prize for Economics. Yet his contribution has really been in the field of economics, since his model stood conventional economic theory on its head and effectively created a new paradigm, which has since spawned an international industry of theoretical models to explain its success. This tells us something about how relatively limited in vision the awards of the Economics Nobel Prize have been. They have focussed much more on narrow academic peer recognition than on addressing real world development issues or processes that actually transform economies.

What exactly was this innovation called microcredit? To understand its significance, it is important to begin with understanding how formal financial institutions operate. Since giving credit is always associated with some risk of default – that is, the borrower not returning the loan amount or paying interest – bankers of all types usually require some form of surety (collateral) against which they can lend. Formal banking institutions therefore require the borrower to have some assets like land or a house, or a secure job, or a certified credit history, or some such assurance against which they will proffer funds.

This obviously eliminates the poor, who are by definition without significant assets and usually also lack secure streams of income through regular employment. So the poor get automatically excluded from formal financial institutions, and are forced to go to private moneylenders who charge very high rates of interest. These traditional moneylenders are able to function in such circumstances because they can somehow ensure that the loan and interest are repaid through extra-economic means, or can extract other forms of payment such a labour services.

It was therefore accepted that the poor were not “bankable” for formal financial institutions, or able to access other financial services such as insurance. Economic theory had also devised many complicated models to explain the necessary persistence of traditional money lending and high interest rates among the poor.

The significance of the Grameen Bank and other microcredit experiments was that they countered this axiomatic belief by showing that even formal financial institutions could provide loans exclusively to the poor and still be assured of repayment. This is because they are based on the principle of “group lending” whereby loans are made to a group (of between 5 and 20 people) and therefore peer pressure acts as an effective mode of ensuring repayment.

Muhammad Yunus may not be the pioneer of microcredit – there were cases of similar experiments in the early 1970s in Colombia and Brazil, for example. But he was the first to make this a viable model capable of being copied and scaled up, and he also became a tireless propagator of the cause of microcredit worldwide.

It all began in 1974, during a famine in Bangladesh, when Yunus was teaching economics at Chittagong University after receiving a doctorate in the US. In his efforts to do something to help the famine-ravaged people in the district, he was visiting nearby villages when he was persuaded to make his first loan in the village of Jobra.

He offered around 7000 Bangladeshi taka from his own funds to a group of 42 bamboo craftspeople in desperate need. They had no collateral to offer, and no contract was signed. Nevertheless, the loan was repaid in full, after the borrowers used the money to buy bamboo, sell their crafts and repay both Yunus and the traditional moneylenders to whom they were indebted.

Yunus drew from this the lesson that the poor can indeed be viable and creditworthy borrowers. But his efforts to persuade banks to lend to them independently were fruitless, as the banks all continued to insist on his personal surety for any loans taken by those without collateral. In any case, traditional banks were simply not interested in making tiny loans at high transaction cost to those with no credit history.

The Grameen Bank was founded in 1976 by Muhammad Yunus as a result of such experience. It was dedicated to serving the poorest of the poor, based on Yunus’ vision that even such very poor people were viable credit risks and could make productive use of small loans to enhance their earning capacity.

The Grameen bank model that emerged had some important features, apart from its concentration on the poor as clients. It involved lending in groups (originally of five members) who were jointly responsible for the loan. It required repayment in small periodic instalments, over a relatively short period. It lent not only to farmers but also to rural labourers, petty traders, and most importantly to women. While at first male borrowers outnumbered their female counterparts, this was consciously altered so that by the mid 1980s women accounted for more than 96 per cent of the loans.

This aspect of lending to women has emerged as one of the more transformatory features of the Grameen model. Women turned out to be much more reliable borrowers, whose loans were used for the well-being of the family. But this also became an important instrument of social change in the conservative patriarchal context of Bangladeshi society. Not only did the access to microfinance improve women’s bargaining power within their households, but the fact of meeting together and being part of groups led to other ways of thinking in a collective mode that proved to be quite empowering.

These features have been emulated not only by BRAC (Bangladesh Rural Action Committee) and Proshikha, the two other large microcredit NGOs in Bangladesh, but across the world, as the focus on microcredit has been an important part of the agenda of multilateral development banks and even of governments. And the focus on women borrowers has proved to be one of the more successful results of the model wherever it has been transplanted.

The spread of this essentially simple idea has been quite remarkable in the past two decades. According to the 2005 “State of the Microcredit Summit Campaign Report”, at the end of 2004 there were 3,200 microcredit institutions that reported reaching more than 92 million clients across the world.

In India too, governments at central and state levels have been actively promoting microcredit, particularly to women, through the institution of Self Help Groups which engage in both savings and loan activities. In some states such as Karnataka and Andhra Pradesh, such organisations has been present for some time now, through the efforts of NGOs such as Mahila Samakhya and Co-operative Development Foundation.

A further innovation has been to form them into federations and link them with formal lending institutions. NABARD (the National Bank for Agriculture and Rural Development) has a scheme whereby it finances more than 500 nationalised banks for lending on to Self Help Groups that have shown they can manage their funds well. The amounts involved are relatively small and the interest rates are also quite high (usually around 12 per cent). Bu the scheme involves very large numbers – around 1.4 millions SHGs comprising nearly 20 million women, making this Indian scheme therefore the largest bank-microcredit linkage in the world.

Despite this spread, and some clear areas of success, it is a mistake to view microcredit as the universal development panacea which it seems to have become for the international development industry. It can at best be a part of a wider process that also includes working towards reducing asset inequalities, better and more egalitarian access to health and education services, more productive employment opportunities.

The undoubted successes of the microcredit model should not blind us to some of the problems and concerns that have been expressed. It still remains difficult to make microcredit a commercially viable proposition for finance institutions. Even in Bangladesh, Grameen Bank and BRAC still depend substantially on subsidies to run their operations despite the high repayment rates, because of high costs of transaction and monitoring. Supporters argue that it is better to spend public money on such subsidies rather than on other forms of public expenditure, since it is cost-effective and responsive to local felt needs.

Yet it is also true that the amounts of money distributed through microcredit are so small and the periods for repayment are so short, that they cannot really lead to effective asset building. Some argue that microcredit at best acts as a consumption stabiliser, reducing the adverse effects of shocks such as natural calamities or seasonal fluctuations, and provides means for taking advantage of very small business opportunities. In the absence of other measures or more dynamic growth processes, this can amount to no more than a redistribution of incomes among the relatively poor, rather than an overall increase in incomes of the poor. It can also be associated with microcredit dependency, involving continued reliance on loans for consumption rather than put to productive use.

Similarly, the group lending that delivers high repayment rates can also become an instrument of stratification, especially when there are linkages with banks providing some additional institutional finance to the groups. There have been cases of women from the most destitute or socially deprived groups being excluded from membership of groups containing better off members, because of fears that their inability to repay will damage the prospects of other members. In some states of India, peer pressure has forced women borrowers to take on expensive loans from moneylenders to repay the loans from the Self Help Group.

A more damaging argument suggests that microcredit programmes can have adverse effects if they imply a transfer of public resources from other public spending, leading to cuts in public health, sanitation and education expenditure. This need not happen, but if it does, then it is akin to a privatisation of public welfare programmes, with unclear effects on overall development. Further, a focus on microcredit should not reduce public attention to ensure adequate institutional finance to rural areas in general, such as agricultural loans and loans to small businesses.

All these criticisms do not detract from the importance of the microcredit model, but they do emphasise that this in itself cannot be seen as the magic bullet to end rural poverty. To their credit, both Muhammad Yunus and the Grameen Bank themselves appear to be aware of this rather obvious truth, since their interventions over the past decades have been characterised by continuous innovation and experimentation. In addition to other forms of microfinance such as insurance, Grameen has experimented with housing loans, loans for fisheries and other small enterprises, venture capital, solar energy projects, a commercial telecom project with a Norwegian partner to deliver cheap rural phones, and now even health care services.

It is this approach, of constantly listening to the actual needs of the poor, of being flexible in terms of continuously looking for new solutions and enlarging possibilities from below, which is the most engaging aspect of Muhammad Yunus’ contribution. Even more than microcredit alone, it may turn out to be his most positive influence.