Microfinance and Small Business: Not in Conflict

James Surowiecki, in this week’s New Yorker, makes a strong case for supporting small and medium-sized enterprises in developing countries. He notes:

In high-income countries, these companies create more than sixty per cent of all jobs, but in the developing world they’re relatively rare, thanks to a lack of institutions able to provide them with the capital they need…

The problem is a dearth not just of lenders but also of people willing to buy an ownership stake in companies, like the angel investors and venture capitalists that American entrepreneurs often rely on.

This is a very good and very important point. But I’m puzzled by the way that Surowiecki frames his argument. The headline of his column is "What Microloans Miss," and he spends much more time talking about microlending than he does talking about the "missing middle". Indeed, he sets up small and medium-sized businesses in opposition to microlending:

What poor countries need most, then, is not more microbusinesses…

Microfinance has led us to focus on lending, but it can be hard for young companies to get big purely on bank loans, which consume cash flow that could be reinvested in the business…

Both socially and economically, microloans do a lot of good, working what Boudreaux and Cowen call “Micromagic.” But the overselling of their promise has made us neglect the enterprises that could be real engines of macromagic.

This I think does a great disservice to people who have spent much time and money and effort in an attempt to help build the institutions which can support small and medium-sized enterprises in developing countries. Do those people wish that they had more in the way of resources? Well, yes, that’s only human. But I don’t think that the microfinance pot is top of their list of liquidity sources to raid. If "we" have indeed "neglected" SMEs in the developing world, that’s our fault for not supporting them more over the past few decades. It’s not the fault of people "overselling the promise" of microfinance in the past five years and thereby somehow diverting money and attention from SME-targeted projects.

I see encouraging the growth of SMEs as complementary to the microfinance revolution. The former has to be done in a top-down manner, by building civil institutions capable of supporting minority ownership rights, that kind of thing. The latter happens in a bottom-up way, by giving one microloan out at a time to some of the poorest members of society. There’s no conflict there, and microfinance, although it’s certainly trendy right now, makes for an unconvincing villain.

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