Vijay Mahajan speaks about new economics and micro-finance

Vijay Mahajan co-founded PRADAN, a rural development NGO, in 1983. A graduate of IIT, Delhi and IIM, Ahmedabad, Vijay has devoted his working life to promoting livelihoods in rural areas.

In 1996, after leaving PRADAN, Mahajan went on to found BASIX, the first for profit microfinance institution (MFI) in India, and among the first in the world to attract commercial equity investments.

In 1998, he co-founded Sa-Dhan, the association of Indian MFIs. In 2001, he helped found the Andhra Pradesh Mahila Abhivruddhi Society (APMAS), a capacity building institution for over half a million women’s self help groups in the state.

• Interview with Vijay MAHAJAN (August 2006)

Q: How do you view the emerging stream of New Economics thinking?

It is not really ‘new’. There have been such responses to the industrial revolution virtually from the beginning. This energy has been differently manifestated at different times. For example, in the 19th century there is the emergence of the Cooperative movement with the evolution of the Rochdale Principles. This was a pan-European phenomenon.

Then there is the work done by David Henry Thoreau on civil disobedience, which Gandhiji later developed further. More recently the tradition of the cooperative movement has gone beyond issues of equity and come to include ecological concerns.

The concerns for equity and ecology strike back whenever the ‘efficiency school’ becomes excessively strong. There is a grand battle, historically, between these streams. However, equity and ecology can sometimes be at odds. And also the efficiency school is not all bad.

Q: Isn’t the essence of New Economics thinking about redefining efficiency in more holistic terms?

Yes, and there are advances being made in this respect. For the longest time there was only one bottom line and it was money. Then there was talk of a double bottom line, which meant monetary and social accountability. But now most leading corporations are trying to perform on a triple bottom line, namely profits, people and planet.

At the World Economic Forum in Davos, I have watched the leaders of corporations at close quarters. I find that there is a genuine questioning among some of them about where we, the world, are going. Sure this is not true of everyone there, but a significant minority within corporate circles is thinking along these lines. It troubles them to see that many young people today despise corporations.

Q: You have said that the power of the free market ethos is somewhat in decline. Why do you feel that?

I was recently attending a conference at the Brookings Institute in Washington D.C., and I could sense that the unshaken belief in the power of the market is a thing of the past. There is now a lot more questioning about the untrammeled power of the market to solve most problems.

Q: Why do you think this has happened?

There are several reasons. Firstly, there has been a clear market failure to address issues of growth and social justice - even within the USA. For instance, about 45 to 50 million Americans are going without health insurance and thus without health care. About 15 to 20 percent of US citizens do not have access to a bank account.

Secondly, the market mechanism has to act through institutions, which includes corporations and regulators. In the last few years, both have shown their under-belly. Attention has also been drawn to the swinging door between the US Treasury, corporate entities like Goldman Sachs and the World Bank/ IMF with senior managers holding power turn by turn in all three spheres.

Q: What are the implications of this in the quest for greater equity and economic justice?

At the same time the State has given in and accepted that it does not have the ability to spend resources efficiently. It is willing to give up the implementation role in many areas. There is also blooming of the ‘third sector’, call it NGOs or civil society, which is initiatives that are neither by the state nor by corporations.

This third sector is being inspired not only by the visionary work of Schumacher and its manifestation in the New Economics Foundation but a host of non-economic thinkers, like the Dalai Lama and Eckart Toole, who are balancing spirit with material growth.

Q: How do you view the NEF’s work on calculating local-multiplier effect in the economy?

Much of it is very simplistic and not conceptually sound. Besides for us in India, the bigger issue is not how the exchange takes place, but what about those who have nothing to exchange.

Q: What are the challenges of fostering economic democracy in India?

There is an urgent need for platforms on which to discuss this question in reasoned and dispassionate ways without knee-jerk ideological responses. Several of the social and economic choices that have to be made have second, third and fourth order issues which need to be openly considered from a more sophisticated 21st century view.

Q: In this context what do you make of all the excitement about the rise of the Indian economy on the global scene?

Most of that excitement is about the ‘visible’ economy. But what really makes it possible is the sweat equity of the millions who make up the true Indian economy. Also let us not overlook that last year the top 2000 companies had combined profits of Rs. one lakh crores, but their contribution to new job creation was minus 18,000. And this would have been minus 87,000 if it was not for the jobs generated by the IT sector. As long as we keep getting ‘Sensexed’ we will not recognize that the true Indian economy is that 93% which is in the unorganized sector. And this sector has not been come to be better recognized and acknowledged over the last ten years.

• Limitations of Microcredit: Five Fatal Assumptions

(Excerpts from Vijay Mahajan’s speech, « From Microcredit to Livelihood Finance », August 2005)

1. Assumption that credit is the main financial service needed by the poor.

Actually it is not. The poor need and want to save much more than they want to borrow. They also want to cover themselves against risks through insurance. However, the field in general does not adequately emphasize other financial services, such as savings and insurance.

Savings are particularly important, as these act as self-insurance in case of smaller contingencies; meet sudden demands of cash such as due to illness in the family; act as margin money or « equity » for borrowing; and finally, to some extent act as a collateral for repayment of loans, where savings are deposited with lenders. The experience of SEWA Bank in India for example, shows that women value a safe place to keep their savings as an important service.

Insurance is another important financial service for the poor, given their vulnerability to livelihood risks. Here, one is not talking so much of life insurance but of crop insurance and insurance for income earning assets such as livestock and irrigation pumpsets. For certain occupational groups such as sea-going fishermen and miners, life insurance is important.

Money transfers are an increasingly important service, as a large proportion of poor households have one or more members of the family migrating for part of the year or several years at a time, in search of work. Thus to focus on micro-credit alone and leave out micro-savings, micro-insurance and money transfers is myopic.

2. Assumption that credit can automatically translate into successful micro-enterprises

This is the familiar debate of « minimalist credit » strategies versus the « integrated » approach to microenterprise promotion. Others, (such as Mahajan and Dichter, Small Enterprise Development, Vol. 1, No.1) argue that there is no one correct approach and that the strategy for microenterprise promotion should be contingent on the requirements of the situation, based on a systematic analysis.

Microcredit is a necessary but not a sufficient condition for microenterprise promotion. Other inputs are required, such as identification of livelihood opportunities, selection and motivation of the micro-entrepreneurs, business and technical training, establishing of market linkages for inputs and outputs, common infrastructure and some times regulatory approvals. In the absence of these, microcredit by itself, works only for a limited set of activities – small farming, livestock rearing and petty trading, and even those where market linkages are in place. The Microcredit Summit Declaration did make a token recognition of this assumption when, in a shift from the draft to the final, they added « other financial and business services » to credit.

3. Assumption that the poorest all wish to be self-employed and can be helped by micro-credit

Most of the proponents of micro-credit as the strategy for poverty eradication make the explicit assumption that the poor would all like to be self-employed. It is true that a certain proportion of poor people do like to take up small farming, livestock rearing, processing, manufacturing or trading activities, but usually they do so to supplement their income from wage-employment. A majority of poor people, particularly the poorest (such as landless labourers in India) want steady wage-employment, on- or off-farm.

Moreover, there is serious evidence that like all other “single” interventions, microcredit works less well for the poorer clients. As David Hulme and Paul Mosley have shown in their important work Finance Against Poverty (Routledge, London, 1996), the increase in income of micro-credit borrowers is directly proportional to their starting level of income - the poorer they were to start with, the less the impact of the loan. One could live with this finding in an imperfect world, but what is really troubling is that a vast majority of those whose starting income was below the poverty line actually ended up with less incremental income after getting a micro-loan, as compared to a control group which did not get the loan. This should stop recent converts from offering microcredit as the solution for poverty eradication, since it can do more harm than good to the poorest.

4. Assumption that those slightly above the poverty line do not need microcredit, and giving it to them amounts to mis-targeting

Though several microcredit programs, including the Grameen Bank, Bangladesh and its replicators have a vast majority of their clients who are poor, mainly landless women, this is not true of a large number of other microcredit programs, including India’s self-help group (SHG)- bank linkage program. Most microcredit programs mainly reach the upper layers among the poor and some, mainly those above the poverty line. Because the microcredit promise was to reach the poor, if not the poorest, this phenomenon is not well regarded.

Yet, access to credit by those who are not among the poorest is not very much better than for the poorest, and what is more, these people generate much needed wage employment opportunities for the poorest. In addition, it enables the microcredit channel to spread its costs over a larger base. To therefore treat any lending to those slightly above the poverty line as mis-targeting is naïve.

5. Assumption that microcredit institutions can all become financially self-sustaining

While one supports the overall move for financial self-sustainability, the assumption that this can be possible for all microcredit institutions, needs to be examined. Even the best cases take too long to get there (e.g. Grameen Bank of Bangladesh in its first 20 years) or have got there by shedding their NGO avatar which needed early subsidies (e.g. PRODEM before it became Bancosol). India’s SHG program has grown big on the basis of external support to the one-time costs of group formation and on going group support costs. With political pressure to lower interest rates on loans to SHGs, even the variable costs are not being met in most places.

Recent studies by CGAP show that only about a 100 of the 10000 odd MFIs round the world are financially self-sufficient. Thus the dual promise that microcredit is able to serve the very poor, and in a financially sustainable manner, is not borne out in practice. Experience shows that either one of these two mutually contradictory goals can be achieved, but not both together.