For quite some time I’ve watch this social experiment where in developing nations small (relative to first world countries) sums of no-collateral loans are made to groups of borrowers too poor to get credit from traditional banks and made by NGO’s. This money is then used by the borrower to start small home based [micro] businesses which enable at least in theory the creation of some form of basic economic sustenance. In a sense it’s a bit of the age old adage “Give a man a fish, feed him for a day. Teach a man to fish, feed him for a lifetime”.
The means to insure repayment within this model were also interesting as since the loans were backed with no-collateral, It was base solely upon the borrowers willingness and ability to repay without the likely hood of physical recourse being taken. To this end an interesting mechanism was put in place, as the borrower had to be part of a small circle of multiple “borrowers” and the repayment of the debt was the individuals as well as the circles responsibility. Great idea right to use peer pressure, well something’s work better in theory then practice.
First off I am sure Microfinance has done well for some, however to set the context my view of this is one of a macro perspective dealing with this as a social-economic issue. Here what caught my eye was a story by Knowledge @Wharton titled “Under the Microscope: Microfinance’s Latest Growing Pains”. Here K@W used a socially proper title as I might have re-titled it as “Microfinance’s In its Final Hours?”.
To summarize the article (which is worth reading in whole) , the following quote from the story pretty much sums things up as “The microfinance sector has experienced a rude awakening by a delinquency earthquake” . Ok, why is this important; simple as this is a micro version of the macro effects of the havoc the major credit markets have brought to the world. It’s also further validation of the Zero Sum Game which many deny the existence of in lue of some win-win dreamland.
Here much like the Wolf 359 story a microcosm exists where we can see its operation in finer detail then our “supersized” world of macro dollars. As let’s look at this world for a minute for starters its closed loop as there is only so much money in the system and its geographically bounded so that too limits the amount of money in the system even further. Therefore, let’s take a remote Indian village as an example and add up all the currency in that community to find the total is 1,000 rupees.
Now we make a microloan from outside of the loop of 10 rupees or about 1% of the gross worth of that system. Then the borrower leverages that 10 rupees to acquire 20 rupees, they then return the borrowed 10 which means it leaves the system, and the system has once again returned to a “zero” state. However what happened is the wealth has now transferred within the system from the many nodes to the few nodes. Now yes the borrower may pay say 4 rupees in cost however this does not invalidate the change in distribution only the percentage.
Now play this causal loop over and over again and you will find the majority of the money say 80% will be held by the few 20% (Pareto’s Law). However this is not the stable state of a zero sum game as there is a constant pressure for the 80% value to be returned to the 80% distribution much as when a wave crashes ashore releasing its store of energy, it then retracts backwards to the sea. This is why failure is such an important aspect to the capitalistic cycle, as it releases back value to the masses which starts the “wave” over again.
Some may use this argument to justify socialism or even communism falsely, as in both of these states wealth is held at least in concept uniformly among the populous in somewhat of a static state. The issue here is this “static” state precludes the chance of “winning”, thus the taking of “risk” which is an intrinsic requirement of a capitalistic economy. Removal or reduction via the application of artificially implied safety nets (social programs) will do nothing more than to create a falsehood within the economic system which will lead to further harmonic disruption in the cycle.
Well many will be asking what is the answer if the system is Zero Sum, and the answer is social affluancy this is why we have personal computers, cell phones, DVD’s, etc. Take for a moment to answer what technology or measure of social affluancy has flown out of a socialistic or even communistic society in the past? Save for Vodka, none of those systems provide for the creation of value only the stabilization of affluancy.
The message here is a hard one, as failure is a necessary evil of any successful system and social pain will need to be felt to achieve social gain in the long run.