Micro-loans (https://moneylendingclub.com) to the very poorest people neither create jobs, growth nor get them out of the misery, according to research by the Swedish economist Pontus Engstrøm.

Microfinance can give some money in your wallet, it can pay school fees or repair a house, and that’s fine, but it does not develop the community around those who can borrow money, emphasizes the Swedish researcher and entrepreneur.

Last year, Engström defended his doctoral dissertation on microfinance at the University of Agder (UiA). The title of the dissertation is “The Role of Finance and Microentrepreneurship in the Informal Economy”. This fall, an article by Engström on new microcredit research is also published in a special edition of the International Small Business Journal.

Understanding Microfinance

The legacy of Yunus

In 2006, the Nobel Peace Prize was awarded to Muhammad Yunus. The Bangladeshi economics professor was granted super-celebrity status for a period of time, and many were excited about his philosophy of ending world poverty through microfinance. Engstrom was among those who liked the message from Yunus but had doubts about how effective microcredit was then, so it came to life.

A few years ago, he was a chief financial officer of Svenska Missionskyrkan, an organization that – via Oikocredit – deals with microfinance in various developing countries. Here, as much as 80 percent of the population is in the informal part of the economy, they do not pay taxes, do not keep accounts or have formal employment contracts. Much research has shown that microfinance did not help people out of poverty, but what were the reasons? He decided to find out how microfinance affects the profitability and growth of micro-businesses.

Knowledge is important

The Swedish economist and two Master’s students from NTNU in Trondheim spent nine months collecting data on 755 small-scale entrepreneurs (business entrepreneurs) who received microcredit in Ecuador. They partnered with D-Miro, one of South America’s most established microfinance institutes. De-Miro had about 40,000 micro-credit customers at the time the research project started.

Engstrøm and his associates analyzed the operation of the small contractors over a ten-year period. The findings were clear, the business owners made some profit on their business, but not enough to grow and expand. And there are no more jobs like that.

These people lack a basic understanding of running a business, so things can get better if they are offered more education in finance. The small contractors think too short-term, they want to improve the economy here and now, not create value in the long run, says Engstrøm.

He thinks there is a positive micro-credit to small businesses that can give the owners a little better life. Still, he believes that the development effect will be greater by directing more of the investment towards medium-sized companies with 10 to 300 employees. Engström points out that this is where the expertise lies in creating more value for each krone invested.

Complex poverty

“Pontus Engström has some good points,” says Bjørn Stian Hellgren, head of microfinance at the Strømme Foundation.

The Power Foundation – together with Norfund and the Mission Alliance – is the largest Norwegian players in microfinance, is active in several developing countries, and has long experience. In 2008, Norfund joined forces with Ferd, Storebrand, DNB, and KLP and started the Norwegian Microfinance Initiative (NMI). Norad also directly supports a number of microfinance institutions.

We have now been in the microfinance industry for a long time, and we have learned a lot. For our part, there has been a much clearer distinction between what is business and investment, and what is aid work. Poverty is complex and more tools are needed. There is a need for assistance, and funding is needed for those higher up in the poverty pyramid, Hellgren emphasizes.