Elyssa Pachico has an excellent round up of the No Pago movement in Nicaragua, which is threatening the future of microfinance in that country. While most of the reporting on the issue has been pretty one-sidedly in favor of the microlenders, mass protests don’t rise out of nothing, and in this case the initiating outrage seems to have been the arrest of six people with overdue debts in Jalapa by a lender called Pro Credit.

The fact is that there are good and bad microlenders, and that it’s a statistical certainty, given the number of such lenders in Nicaragua, that a pretty large number of them are bad. (Borrowing cheaply in dollars, lending at high rates in local currency, and acting only with an eye on their own bottom line — standard predatory lending, basically.)

Nicaraguan president Daniel Ortega has failed to condemn the protests, which are surrounded by all manner of rumors. You just knew that Hugo Chávez would be involved somehow:

Complicating matters is the widespread suspicion among No Pago opponents that the real intention behind the movement is to drive MFIs out of business, forcing poor farmers to seek credit through Alba-Caruna, a credit union created by Ortega’s government that is partly responsible for handling aid money from Venezuela. In one strange twist of events, a letter supposedly signed by Omar Vilchez was unearthed last January, in which he promised unwavering support for Ortega’s political initiatives in exchange for dismantling the microfinance industry.

“It is necessary to combat the financial system privatized in 1990, to stop depending on MFIs and banks, so that all can work with the people’s bank, with Alba Caruna, which gives us fair interests rather than usurious ones,” the letter states.
Vilchez has vehemently denied that he ever wrote such a letter, even offering to have his handwriting examined by the police so as to prove that his signature was forged. The leaders of the No Pago movement have repeatedly rejected the accusation that they are working in cahoots with Ortega’s government, asserting that they are independently funded and politically autonomous.

My feeling is that microfinance works best when it’s domestic, autonomous, and where the microlenders are cooperatives owned by their own clients. In general I get suspicious when the lenders and the borrowers come from very different populations, and even more suspicious when they come from different countries. If westerners want to support microfinance, they should do so with grant equity, not through loans: the debt in the organization should be local.

I’m beginning to sniff the beginnings of a backlash against microlending: the NYT, for instance, today covers a pretty minor development at Kiva, which has recently changed its documentation to make it more obvious that its US lenders are supporting microlenders rather than lending directly to borrowers. (But they take the full credit risk of an individual borrower, which is one reason I’m not a huge fan of the Kiva model, except as a way of giving ordinary Americans a real connection to policies and people in far-flung countries.)

Microlending can do good, but it can also do harm. And when tens of thousands of borrowers start threatening their local microlenders, that’s prima facie evidence that something has gone horribly wrong. And that the microlending movement, in the country in question, might have gotten rather ahead of itself.

In the wake of my blog entry last month saying that people shouldn’t invest in microfinance, I had the opportunity to meet yesterday with Premal Shah, the president of Kiva. Kiva is an interesting case, and I don’t consider Kiva’s lenders to be microfinance investors — not least because they get no interest on their money. The best-case scenario is that they’re paid back what they lend, and the worst-case is that they lose it all. That’s not much of an investment.

With Kiva, the interest is more literal — they take a real interest in the individuals to whom they’re lending. That’s why Kiva loans are structured as loans to individual borrowers, rather than as loans to the local microlenders. Lending to microlenders is the way that most microfinance finance is structured, and it’s the logical way of doing things. But there’s less human-as-opposed-to-financial interest there. At Kiva, says Premal, “What makes it all work is the story engine.”

Premal says that when visitors to kiva.org lend money, the rate of return they’re looking at is social impact, rather than anything financial. That makes sense. And indeed they have a much greater risk appetite than most socially responsible investors: they’re reasonably happy to take modest losses, especially when it’s a result of circumstances outside the borrower’s control, such as exchange controls imposed by the government in question.

Given the fact that Kiva has a greater risk appetite than most investors, it tends to work at the riskiest end of the microfinance spectrum — places like Iraq and Liberia. That’s pretty cool. But it does share a couple of structural problems with the world of microfinance investors more generally. The first is that there’s too many dollars and too few microlenders: what’s really needed is not more money, but more people in rural areas willing and able to lend it.

The second problem is the way in which much microfinance investment is at heart a gussied-up carry trade: investors fund in dollars and then lend out, at very high nominal interest rates, in foreign currencies. Kiva has started to address this problem with an opt-in scheme whereby lenders take FX risk after the first 20% of local-currency devaluation, thereby preventing microlenders from having to pay back, in local-currency terms, much more than they borrowed. It’s a start, but I don’t like the way that microlenders have to opt in: it should rather be opt-out, since the scheme is free. The microlenders who opt out will have privileged access to the minority of Kiva users who don’t want to take any currency risk, but those users shouldn’t really be lending money to foreign-currency borrowers in the first place.

My feeling is that where Kiva works best is in giving ordinary Americans a real connection to policies and people in far-flung countries; it’s also probably the best way in which microfinance lenders can take advantage of dollar-denominated funding. That said, such microlenders should always look for grants before loans, and for local-currency funding before anything in dollars. So Kiva, while not necessarily a last resort, should maybe be the second-to-last place they look for capital.

Update: I’ve realized this was pretty unclear in that I use the term “lenders” to refer both to the Kiva visitors, lending in dollars, and to the local microlenders, lending in local currency. So I’ve changed all the “lenders” to “microlenders” where appropriate. Of course the Kiva visitors can be considered microlenders themselves, but that just gets confusing.

Unicef reports:

UNICEF today released new figures that show the rate of deaths of children under five years of age continued to decline in 2008.

The data shows a 28 per cent decline in the under-five mortality rate, from 90 deaths per 1000 live births in 1990, to 65 deaths per 1000 live births in 2008…

The data shows global under-five mortality has decreased steadily over the past two decades, and that the rate of the decline in the under-five mortality rates has increased since the 1990s. The average rate of decline from 2000 to 2008 is 2.3 per cent, compared to a 1.4 per cent average decline from 1990 to 2000.

The bad news is that infant mortality is still far too high, and is highly concentrated: just three countries — India, Nigeria, and the Democratic Republic of Congo — between them account for 40% of the world’s under-5 deaths. And in countries like South Africa where a large number of women of child-bearing age have HIV/AIDS, that’s going to show up in infant-mortality figures as well.

But the good news is that significant advances in things like infant mortality can be made even when wealth and growth are low, especially with targeted development aid. Let’s have more bed nets!

Ana Carvajal and Jennifer Elliott of the IMF have a new paper out which takes international data from Iosco, the International Organization of Securities Commissions, and looks at how assiduous regulators are in about 80 different jurisdictions. They’re looking at enforcement, which comprises three Iosco principles:

Principle 8: The regulator should have comprehensive inspection, investigation and surveillance powers.

Principle 9: The regulator should have comprehensive enforcement powers.

Principle 10: The regulatory system should ensure an effective and credible use of inspection, investigation, surveillance and enforcement powers and implementation of an effective compliance program.

They then chart whether these principles get implemented better as countries get richer:

The upshot is that although securities regulators’ legal powers are generally pretty much in place in poorer countries, they’re not effectively implemented there — in order to have any faith in your securities regulator, you basically need to live in a high-income country.

There’s also that interesting dip, in the lower chart: securities regulation is actually less effective in upper middle-income countries than it is in poorer countries. Maybe that’s because the elite in poor countries don’t need to flout securities laws to get rich: they only start playing in domestic markets, and enjoying de facto impunity there, when their countries become that much more developed.

It’s good that the WSJ is taking a skeptical look at the excesses of PE-funded microfinance institutions, even if the newspaper still feels the need to put the word “microfinance” in scare quotes in its headlines.

I’m a fan of genuinely local, bottom-up microfinance. But what the WSJ is talking about — which is where the real growth is — is top-down microfinance, driven by external funds from the developed world. Ethical funds, in particular, love these investments, partly because they have very little correlation with any other asset class, and partly because everybody loves to think they’re investing in the next Grameen. The problem is that Grameen never took foreign money, for a very good reason.

At heart, a lot of these investments are a gussied-up carry trade. Developing-country financial institutions borrow dollars, and invest them in the local markets, with little if any currency hedging. A few organizations are beginning to offer hedging services to microfinance institutions, but such services are unlikely to prove particularly popular, because it’s that implicit FX risk which accounts for a huge proportion of these institutions’ profits. Much better that microfinance organizations grow a little more slowly, and much more organically, either by getting grants rather than loans, or by funding themselves locally.

It’s undoubtedly true that microfinance could be a lot bigger than it is now. But the way to get there from here isn’t to throw for-profit private-equity dollars at it. The real constraint is finding and training good local women who can underwrite well and who know their customers on a personal level. There’s a reason that these PE-backed microfinance dollars are concentrated in cities right now: it’s the only way to scale up quickly. But speed is the enemy of quality, as the WSJ’s Ketaki Gokhale demonstrates, and in Ramanagaram it has resulted in the local mosque successfully urging its congregation to default on all their loans, with stubborn uncooperativeness on both sides:

The mosque leaders are also demanding that lenders give them an accounting of their finances. The lenders say they’re not about to comply with that.

Any microfinance institution which so easily angers and refuses to cooperate with local religious institutions is walking on very dangerous ground. If western do-gooders want to support microfinance lenders, they should simply donate their money to grassroots organizations in the developing world. If they want to make a profit, they should stick to more conventional investments.

One of the great things about making your entire book available for free online is that it gets read by all types — even Glenn Hubbard. And since Hubbard has a book of his own to plug, he’ll even enter the aid debate in public. He doesn’t have his own blog, so here’s Glenn Hubbard on Charles Kenny.

Economists and policymakers have engaged in a lively debate over the past quarter century on how best to encourage economic development. Much of this discussion centers on the economic woes of sub-Saharan Africa.

It’s not hard to see why.

Roughly equivalent to the per capita GDP of South Korea in the mid 1950s, the economies of most sub-Saharan African nations have fallen steadily behind since 1960. As South Korea became a high-income OECD country over this time frame, most of Africa remains mired in dire poverty. In throwing out the bathwater of colonial rule, many of the new nations of Africa threw out the baby, too – the liberal business system with it.

We worry too much about GDP growth, says Charles Kenny in his provocative new book THE SUCCESS OF DEVELOPMENT: The quality of life is improving around the world. Says Kenny, “A greater focus on proven approaches to more rapid improvement in health and education may have a significantly greater impact on the quality of life of poor people in poor countries than yet another quest for the grail of GDP growth.”

If only.

There exists no consensus on the merits of Kenny’s arguments for a new big push for quality of life. In the 2004 report of the Barcelona Development Agenda and the 2008 report of the World Bank-sponsored Growth Commission concluded that there is no single set of policies that can be guaranteed to ignite sustained growth. By contrast, much more consensus among economists exists for the power of a vibrant business sector in making possible entrepreneurship, innovation, and growth. The largest sustained per capita growth outliers in recent years are the East Asian tigers, India, China, and Africa’s Botswana and Mauritius, all thank to business, not aid.

In a forthcoming book, THE AID TRAP, Bill Duggan and I focus on BUSINESS as a driver of both growth and economic and social well-being in Africa, just as it has been in the west. Aid focused on charity may still be worthwhile – though that, too is the subject of debate, as Dambisa Moyo’s book DEAD AID points out. But it is reducing barriers to business that can lift prospects for growth and innovation. And the creation of a vibrant domestic business class thrusts forth a political constituency for reform and support for education.

Policy has made advances here beyond the siren calls of rock stars. I admire the Bush administration’s U.S. Millennium Challenge initiative for its attempt to condition additional aid on institutional reforms that could promote business development. Upon closer inspection, though, the Millennium Challenge Account reverts to a top-down approach.

Kenny intends his insights to change the global policy agenda. While defending aid as “(playing) a part in improving quality of life outcomes,” he argues for more support for “global technology and the spread of ideas.”

Yes, but…

As Duggan and I argue, it is a vibrant domestic business sector with supporting business institutions that enables a country to seize the benefits of globally available gains in science and technology.

And to what end? No less than Abraham Lincoln furthered this thought in his famous historical recapitulation:

The advantageous use of steam power is, unquestionably, a modern discovery. And, as much as two thousand years ago the power of steam was not only observed, but an ingenious toy was actually made and put in motion by it, at Alexandria in Egypt.

What appears strange is that neither the inventor of the toy, nor anyone else, for so long a time afterwards, should perceive that steam would move useful machinery, as well as a toy.

The answer to President Lincoln’s question is the ability of business and business institutions to seize the day. To bring President Lincoln’s point to the present, aid can help promote access to drivers of a better life. But it can best do so through advancing business. In THE AID TRAP, Duggan and I argue for a Marshall Plan for Africa.

We cannot and should not stop the flow of aid. There will always be a role for charity, as there is in all rich countries. Giving food, clothing , shelter, and medicine to the poor is a long and noble tradition. That is a good thing. But it is very different from aid for economic development, to bring people out of poverty. For that, we must direct aid to support the business sector – as in the Marshall Plan of post-World II Europe.

Many people think the Marshall Plan was charity aid – food, clothing and medicine for war-torn Europe. But that was the United Nations Relief and Rehabilitation Administration. The Marshall Plan came later. Its single aim was a thriving domestic sector in every single country. And it worked. Aid can indeed help to end poverty, by helping the business sector. The Marshall Plan shows how, as Duggan and I spell out in THE AID TRAP.

Kenny’s very interesting book is right about two big things.

The first is the need for modesty: Aid advocated from Rosenstein-Rodan’s “big push” to Jeffrey Sachs’ call for ambitious global spending aim at nothing less than top-down transformation of economies and societies. Not only is such an approach at variance with the west’s trajectory toward prosperity, it has not worked. After nearly one trillion dollars of aid since World War II, much of sub-Saharan Africa remains mired in dire poverty.

The second is attitude of optimism: As global citizens, we should not accept the consignment of tens of millions of Africans to extreme poverty. And we can make progress. But it will be more in the way of Friedrich Hayek than Selma Hayek (to borrow a phrase from Bill Easterly). It will be through a concerted effort to promote a vibrant business sector from the bottom up.

But will bottom-up approach improve the quality of life.

Yes. As my Columbia colleague Edmund Phelps noted in his lecture accepting the 2006 Nobel Prize in Economics, workers are more satisfied in dynamic economies with a robust entrepreneurial sector and support for research and development.

So economic growth may not be so removed the good life after all.

I’ve been glued to my Kindle all day, reading Charles Kenny’s compelling and important new book, The Success of Development: Innovation, Ideas and the Global Standard of Living. Kenny is a great writer, and his book is a true pleasure to read; it’s also a crucial addition to a development literature which has gotten bogged down in debates which will never be satisfactorily resolved.

The Success of Development acts like a sword through many of the Gordian knots plaguing the development community, especially those surrounding the rate of economic growth in many developing countries. Put that question to one side, says Kenny, and suddenly a lot of much more interesting questions, about issues like education and healthcare and clean water and human rights, come into a lot more focus. And if you use those metrics, rather than GDP growth, to judge the success or failure of developing countries, then things look rather more optimistic than you might think.

Wonderfully, Kenny has made The Success of Development available as a free download from his website, so you have no excuse not to read it — or at least the short 5,600-word introductory chapter which lays out substantially all of the themes of the book. Here’s a taster:

Thousands of papers and articles attempting to divine the causes of long term economic growth around the world, testing hundreds of possible determinants, have produced results that are contradictory and inconclusive. Perhaps this isn‘t surprising given the heterogeneity of countries that have seen fast growth. Between 1929 and 1988, eight countries in the world managed to more than quadruple their per capita GDP: Japan, Taiwan, South Korea, Italy, Norway, Finland, Bulgaria and the USSR. It might be hard to come up with a single policy explanation which could account for rapid growth in all of these very different economic regimes…   

Related to this, looking at almost any measure of the quality of life except for income suggests ubiquitous improvement. The general picture is of rapid, historically unprecedented progress in quality of life –progress that has been faster in the developing world than the developed. This is true for measures covering health, education, civil and political rights, access to infrastructure and even beer production. Since 1960, global average infant mortality has more than halved, for example. Nine million children born in 2006 celebrated their first birthday who would have died before then if mortality rates had remained at their 1960 level. And the vast majority of those children lived in developing countries…

the proportion of the population of Sub-Saharan Africa affected by famine over the 1990-2005 period averaged less that three tenths of a percent. The proportion who were refugees in 2005 was five tenths of a percent. The number who died in wars 1965-2001 was one one-hundredth of a percent. These figures add up to stories of despair for many millions in Africa –but they remain stories of the small minority. For the rest, progress has been considerable. Take literacy, for example –the percentage of Sub-Saharan Africans who could read and write doubled over the period 1970-1999, from less than one in three to two thirds of the adult population… Between 1962 and 2002, life expectancy in the Middle East and North Africa increased from around 48 years to 69 years.

The biggest success of development has been in making the things that really matter – things like health and education—cheaper and more widely available… We do not appear that knowledgeable on the subject of increasing the speed of income growth, as we have seen. In contrast, we appear considerably better at improving the broader quality of life for everyone, at whatever income. A greater focus on proven approaches to more rapid improvement in health and education may have a significantly greater impact on the quality of life of poor people in poor countries than yet another quest for the grail of GDP growth.   

Kenny is soliciting feedback from anybody who downloads and reads the book; I very much hope that among that feedback will be an email from a literary agent who hopes to be able to place this book with a major publishing house who will put some serious effort into promoting it. Given the success of simplistic books on development by the likes of Jeffrey Sachs and Dambisa Moyo, this more subtle, more realistic, and much more readable book should by rights do really well commercially. And when it does, you can be one of those smug people saying that you read it back when it was a free download from blogs.com.

I spent some very pleasant time this afternoon with Larry Coben, a man who seems to spend most his life making the world a better place by globetrotting around sites of extreme architectural interest. Nice job that man! His Sustainable Preservation Initiative is all about taking architectural sites in poor countries and making them generate cash for the locals — thereby giving them a real monetary incentive (rather than a high-minded lecture) aimed at preserving archeological treasures. It’s “economic development in an archeological guise,” he likes to say.

A lot of the money comes from tourism, in communities where a little tourism money can go a very long way. You can start with simple admission fees, but then scale into all manner of other money-making schemes: replica handicrafts, for instance, or even, in the case of one site in Armenia, making wine as the ancients did. There’s a huge amount of opportunity here, says Coben: “I’ll be dead before we’re through the low-hanging fruit”, he reckons, just because the costs of these schemes are low (in the $10,000 to $30,000 range) and the number of possible architectural sites is enormous. The slogan of his organization is “saving sites by transforming lives”.

One intriguing aspect of Coben’s initiative is its use of debt finance: he wants the schemes, where possible, to take not only grant money from donors but also to borrow funds from local microlenders. Having to pay back a loan is “a great discipline”, he says — and when microlenders are invested and want to get their money back, they also act as semi-formal overseers of the project, obviating a large amount of the need for foreign donors to keep an eye on things. Essentially, Coben is outsourcing supervision of the projects, and recycling funds into the community at the same time. He does intend to keep a substantial equity stake in the projects, just so that he can intervene if things go wrong, but at no point will dividend any money out of the local community.

Coben’s starting out with one project in Peru as well as the one in Armenia; he’s already demonstrated what’s possible with a similar scheme he organized himself in Bolivia, which involved little more, at the outset, than simply putting up a toll gate. The universe of architectural tourists isn’t particularly large, but it doesn’t need to be: just a handful of tourists per day, paying maybe $10 apiece, can transform the economics of many remote villages. That’s the kind of money, as a tourist, that you want to spend — as opposed to huge luxury-hotel bills most of which go straight to multinational corporations. This is a great idea, and I hope that it really takes off. Even the worst-case scenario — where the projects fail — is a significant improvement on not trying at all.

I was on The World Today this morning, talking about vulture funds:

The bill they’re talking about is this one, which is very similar to the Stop Vulture Funds Act being pushed by Maxine Waters in the US. Essentially it says that if you lend money to a country you have the right to get your money back — but if you then sell that loan to someone else after it has gone into default, the person you sold it to does not have the right to be repaid in full, and instead can only be awarded the amount they originally paid for the debt, plus a small set interest rate.

In other words, the single greatest innovation in the history of debt capital markets — the idea that obligations can be traded, rather than just being held to maturity or litigated upon default — is destroyed at a stroke.

What’s more, the problem these bills are trying to solve is absolutely minuscule. Not only are vulture funds settling their debts for three cents on the dollar, but they more generally have had a very hard time indeed successfully collecting on court judgments around the world. That’s why litigation is a last resort for vultures: anybody who thinks that they buy up this debt with the intention of litigating for repayment in full simply doesn’t understand the business model.

The good news, however, is that neither the UK nor the US bill has any chance of making it into law: the governments in both countries, for all that they’re nominally left-wing, would never support either piece of legislation. This is basically theatre on the part of lawmakers, not a serious and thought-through attempt to rewrite the international financial architecture. If it were, maybe the lawmakers in question might have asked developing countries what they thought of this legislation. And they might well have been surprised at the answer, which is that countries want no part of any act which might hinder their access to capital or their equal-player status on the world stage.

Anti-vulture-fund legislation like this is paternalism of the worst kind: it might be well intentioned, but at heart it’s a bunch of ill-informed northerners telling impoverished southerners what’s good for them. If and when vulture funds ever become a real problem — which I doubt will ever happen — then I fully expect to see the afflicted countries coming up with their own suggested solutions. In the meantime, let’s not exacerbate the plight of those countries by cutting off whatever access to international capital that they currently enjoy.

Update: Sandrew has a very good comment.

At a panel this morning on community development finance, there was lots of talk about capital constraints and liquidity constraints and in general the way in which the funding for community development lending has completely dried up, despite the fact that such lending has massively outperformed most of the credit product out there.

The problem as I see it is that much of the funding has historically come through trying to be just a little bit too clever in terms of taking advantage of the more conventional banking system. Lots of community development finance has come from banks looking to get into compliance with the Community Reinvestment Act; or investors with taxable profits looking to buy things like low-income housing tax credits; or foundations looking to help provide leverage without risk by using the tools of structured finance, with securitization giving them the opportunity to invest in securities carrying a triple-A rating.

Today, of course, banks have much bigger things to worry about than CRA constraints; they don’t have taxable profits which need to be offset with tax credits; and faith in the tools of structured finance is at an all-time low. But the panelists still felt that they had to continue to push the old model — “none of us would be here”, said the moderator, Betsy Zeidman, were it not for the tools of structured finance being repurposed to what are often called “double bottom line” institutions.

This makes sense: there’s really no alternative out there able to provide the billions of dollars in funding which has flowed into the community-development space from the broader financial sector. On the other hand, with the broader financial sector shrinking, alternatives are going to have to be found somehow. There was talk about letting community development financial institutions borrow from the Federal Home Loan Banks on the same terms currently available to commercial banks — that seems like a good idea to me, so long as the Federal Home Loan Banks are up and lending (they have big problems of their own).

But it was clear that over the long term there’s a big need for community development financial institutions to get smarter and leaner about how they operate, by outsourcing a lot of the back-office and risk-management operations which are often at the moment performed haphazardly by institutions far too small to do them well. The problem is how do we get there from here — we don’t yet have the kind of institutions capable of providing efficient back-office services to a large number of small and largely non-profit lenders. Any laid-off bankers care to try founding one?