Microfinance: The Best Bang for Your Buck?

Here's an interesting article on how to get the most bang for your buck when using your money to help others. The article asks the question of how to put your money to its most effective use in doing good for other people. This question perplexes me and is a big part of what got me interested in pursuing my PhD in economics.

Interestingly, this article concludes that micro-finance is the best option. It gives feedback for the effectiveness of the programs (people pay you back if it's working), which in turn allows your funds to grow to help more people. It also works to empower others to become entrepreneurial and teach them the rewards of productive work. This treats people with dignity and avoids the problems that often occur of creating dependence when trying to help others.

I had the tremendous privilege of working with a micro-finance organization in Moldova this past summer and was very impressed with the work they are doing and the impact they are making in the lives of many Moldovans. It is a fantastic organization and is definitely doing some wonderful work.

As much as I love microfinance, however, I also recognize the need for these efforts to be combined with institutional reform. The reason many developing economies remain stymied with sub-par growth and rampant poverty is because of break-downs in their political and legal systems. The lack of law enforcement, government corruption, barriers to business development and unstable property rights all create ripe environments for black markets, crime and poverty. I often say:

"You will never remodel your kitchen if you're not sure you can keep your house."

What I mean by this is that people will not engage in productive behavior with full vigor if they are not certain they will be able to keep the fruits of their labor.

What is the best way to engage in this struggle? That is a question I am currently researching and struggling with. I believe a two-pronged approach is needed --

1. Top-Down: Supporting institutional change in poverty-stricken regions. Particularly instituions that support economic and political freedom, predictable and stable legal systems, and strong property rights. Also important is breaking-down trade barriers between the developed and developing world. This not only helps people in these areas to develop their own businesses, but it also makes the regions more attractive to foreign investors.
   
2. Bottom-Up: Engaging in micro-finance work, assisting in education, development of infrastructure, and helping to meet immediate daily needs of people in developing areas.

Both approaches are necessary and should be engaged in simultaneously.

For further reading, Cafe Hayek had a great post on microfinance last year. Here's an excerpt:

George Mason University economics graduate student Steve Daley and the Mercatus Center’s Brian Hooks wrote this very nice op-ed being distributed today by UPI. It’s on microfinance – a topic that these guys know very well.

...as Daley and Hooks explain, the root reason that significant economic growth in most poor countries doesn’t happen is not lack of capital. It’s dysfunctional institutions – dysfunctional regulations and laws, and dysfunctional social norms.

Capital will go to where investors expect to earn good returns. Investors will come to expect to earn good returns only when and where property rights become more widespread and secure and where both laws and social norms at least tolerate economic change, entrepreneurial success, and the commercial spirit.

There's a lot more to be said on these topics and I hope to follow-up further in future posts.