ps re SRI

By the way, I actually think SRIs are probably not such a great idea for Serbia at this point in time. It simply doesn't, so far as I can tell - and I haven't been in Belgrade for a while, true, so maybe it is all much improved and I haven't caught up - have a governmental culture for regulating charities that would allow it to work. Too much corruption and governmental political influence. In fact, I probably don't really think there is great room to expand SRIs into lots of countries around the world - for the same reasons, and also that most countries, really, can't do even basic charities regulation effectively, let alone SRI. Better to have SRI function internationally through countries that have effective charities regulation, and funnel the funds raised to other places in the world.

Hmm. I think I had better drop a note to the editor and amend that opening paragraph - I need some diplomatic way to phrase it, however, because the whole premise of the special issue seems to be, more or less, this is the cool thing in the Western charitable sector, let's do it here!!!! To which the real answer perhaps should be - in Belgrade, in a government containing many corrupt functionaries, the influence of gangsters, and Milosevic leftovers, are you kidding? Let's get basic charities regulation functioning, first, and then look to SRI structures.

(Also, I haven't noted the most basic arguments over SRI, except by implication: first, how do you show that the market's allocation is not the socially efficient one and, second, if it is that socially important, shouldn't government do it directly? I do think SRIs can be a very useful charitable activity, but the article is a bit too cheerleading, on reflection.)

Socially Responsible Investing (SRI), a primer for a Serbian magazine

At the media forum in Guatemala last week, I was asked by a Serbian editor if I would contribute something very short and general on socially responsible investing to a special issue on the subject of a Serbian business magazine. Something very readable for a general audience to explain what the idea is about and what kinds of laws and regulations you need to make it possible. Here's my effort - I am not very good at explaining things to general audiences, so I have encouraged him to simplify and shorten things.

***
What It Takes for a Society to Have Socially Responsible Investing

Socially responsible investing (SRI) is an increasingly popular mechanism by which individuals and organizations can engage in charitable activities. It is an especially growing activity of the nonprofit and nongovernmental organization sector in the United States and Western Europe, and has great promise to expand elsewhere in the world.

But SRI is a very special nonprofit activity, and for it to be successful in a society, SRI requires some crucial legal, regulatory, economic and social underpinnings – if these are present, then SRI can be an important tool in charitable and nonprofit work in a society, and in international philanthropy. If they are not, then there is a possibility of SRI backfiring and damaging the whole nonprofit sector. It is therefore very important to get the regulatory and legal rules right for SRI, and to understand that it is a specialized tool of nonprofit activity and not an answer for everything.

Stripped down to its essence, SRI is a practice by which either individuals or organizations – which might be regular for-profit businesses, such as banks or corporations, or non-profit organizations, such as charitable foundations – invest part of their funds in economic activities that are considered to be socially valuable but which might not ordinarily receive the funding from the market that is considered socially optimal. The basic idea is that the money is not donated in the ordinary sense of given to a charity, and then it is gone from the donor’s hands. The idea behind SRI responsible investing, on the contrary, is that it is an investment in a charitable activity, usually as a loan, which is to be repaid to the person who made the loan.

This socially responsible lender, rather than receiving the full market rate of interest, however, makes a conscious decision to accept either no interest on the loan or else a discounted interest rate – something less than the full market rate of interest. The money is intended to return to the lender, and so is not a donation. What is donated is the interest on the money that might have been charged.

In the case of individuals, that money can come from one or both sources. It might be money that the individual planned to contribute to charity anyway as an outright donation, and instead makes as a loan. People who do that – who planned to donate the money anyway to charity – frequently take the repaid loan and do another SRI loan, to the same organization or to another one. Alternatively, the money might come from funds that the individual planned to save – for a rainy day, for retirement, for all the reasons people save money. In that case, of course, the individual cares a lot that the money will be safely repaid – it is not money the individual planned to give away, but only to loan for a while.

In the case of for profit businesses, the legal rules in the United States and most other advanced economies permit the boards of directors of corporations to make reasonable contributions to charity in the name of the corporation. And so instead of making a straight donation, the business might instead loan the money at no or low interest rates. Alternatively, just as individuals might take some of their savings and put them into SRIs, a business might take some of its regular investment funds and put them into SRIs – and just like an individual, the business cares a lot that it get repaid.

Of course, all this means that the charity that receives the money must be the kind of charity that can repay a loan. Most charities are not like that, as a matter of fact. If you give money to a charity that uses the money to feed poor children or buy them winter clothes, the simple fact is that that kind of charity has no real possibility of earning money to pay back a loan. It's not (we hope) planning on charging the kids for the food or clothing. It is a charitable organization all about giving. It needs donations because its charitable activity is donating things. Think of it as an “intermediary” that takes donations from you, but knows better than you do who really needs that donation and why, and then makes sure it gets there. SRIs typically don’t make sense for those organizations – and they are most of the charities in the world – because those organizations don’t generate income apart from donations.

The organizations that can use SRIs are typically the specialized range of institutions that do generate their own funds, and can repay the amounts that are loaned to them. Examples would be schools that charge tuition – even if that tuition is very reduced, to subsidize the children, for example, still, over time there is an independent stream of income that can be used to repay SRI loans. What this means, really, is that an NGO that has a stream of income, from tuition payments, for example, can borrow at a zero interest rate through SRIs rather than financing itself – to build a new school building, for example – through loans on the market at full market interest rates.

This is a very valuable economic resource, but it only works with the kinds of charities that actually bring in their own money. But the numbers of charitable organizations in the world that do have their own streams of income from which they can, over time, repay SRI loans are increasing – especially as microfinance, which makes small, “micro” loans to poor people, especially women, in the developing world to create small businesses, grows. Those micro-businesses repay their loans, which in turn can repay the SRI loans.

If that is what SRI is all about, what kinds of legal, social, and economic structures make it possible?

In the first place, there has to be in place a solid social tradition of making charitable donations in the first place. In a lot of places, this is not true – all this work has traditionally been seen as the role of government, not charitable donations. But this view is gradually changing, to accept that although government has a large role to play, so do individual charitable donations. But to help persuade individuals and businesses to make charitable donations, there needs to be a reliable, stable set of government rules to make sure that donated funds are properly used, properly accounted for, go toward strictly charitable activities, and do not simply leak away in corrupt activities.

Second, once a society has in place a solid structure of legal rules for charitable contributions – straight out giving – it needs the special structure of rules for SRI loans. What makes this special and different from regular contributions to charity is that individuals and businesses who make these loans are genuinely looking to get paid back. There needs to be a regulatory and legal structure in place so that these loans really are treated, for legal purposes, as enforceable loans, even if they carry a zero or discounted interest rate.

Remember – often the most important source of SRI funds comes, not from money people were already planning on donating, but on people’s savings, money they are counting on having back, as part of their retirements and other reasons. They will not hand over the money for SRIs unless they have strong reasons to think they are legally protected that the loan will be repaid. Even if they are legally protected, technically, the difficulty of going through legal mechanisms - lawsuits, courts, etc. - mean that they must additionally feel comfortable that the organization will repay even without the threat of the law.

And so they will additionally require assurance that the money will be properly accounted for within the charitable organization. That requires legal rules ensuring that these loans are as legally enforceable as any other loan, although it is a loan made to a nonprofit charity. But it also means legal rules that ensure that nonprofits are monitored by neutral, objective government charity agencies to ensure that they are following proper accounting rules. Problems of unaccountable charities need to be caught before they turn into financial scandals, if possible. But that requires, of course, that the government agency really be about neutral, objective accountability - not a means of political control by the government. Governmental watchdogs over charities mean one thing in Britain and a whole other thing in Putin's Russia.

These are important legal and economic requirements in order that SRIs can work. But the benefits of SRIs are becoming increasingly clear in places where the rules work well. Money can be recycled in the charitable sector, and the fact that it is recycled and not simply donated helps force nonprofit organizations to be more efficient in their work. Many variations of these basic patterns exist - an SRI investor accepting greater risk, for example, that the loan will not be repaid for the sake of the activity. SRIs are not for every kind of charitable organization but, with the right governmental regulations, they are a new and important tool of the nonprofit sector.

William Easterly in the LAT on economic development successes in Africa

As William Easterly says, it is much too soon to say whether some favorable economic growth and development trends in parts of sub-Saharan Africa will be permanent. Political instability, for example, can wipe out years of slow improvements in a historical heartbeat. Nonetheless, he says, it would be a mistake not to recognize such improvements as are occurring, in no small part because they indicate the path forward. In the LA Times, here, "What Bono Doesn't Say About Africa," July 6, 2007, opinion page:

In truth, Africans are and will be escaping poverty the same way everybody else did: through the efforts of resourceful entrepreneurs, democratic reformers and ordinary citizens at home, not through PR extravaganzas of ill-informed outsiders.The real Africa needs increased trade from the West more than it needs more aid handouts. A respected Ugandan journalist, Andrew Mwenda, made this point at a recent African conference despite the fact that the world's most famous celebrity activist — Bono — was attempting to shout him down. Mwenda was suffering from too much reality for Bono's taste: "What man or nation has ever become rich by holding out a begging bowl?" asked Mwenda.

Perhaps Bono was grouchy because his celebrity-laden "Red" campaign to promote Western brands to finance begging bowls for Africa has spent $100 million on marketing and generated sales of only $18 million, according to a recent report. But the fact remains that the West shows a lot more interest in begging bowls than in, say, letting African cotton growers compete fairly in Western markets (see the recent collapse of world trade talks).

As time goes by, Easterly is decisively winning the intellectual battle between his approach to poverty reduction and economic development and that of his main intellectual rival, Jeffrey Sachs. The two share some important things in common, true, but Sachs, over the past few years, has gradually evolved a top-down, 'aid money is the fundamental factor', Soviet-style central planning quotas-and-goals, five year plan approach that has proved so useless in the past. It dovetails with Sachs' position as UN advisor on how to create precisely such command-economy five year plans at the grand UN level. It is profoundly reactionary. And it's a great pity, because Sachs is obviously brilliant and committed - but his ideas, at this point anyway, are wrong and known to be wrong on the basis of what has gone on before in Africa and elsewhere. This is not to exaggerate the ability of markets and trade to address extreme poverty in Africa - there is an enormously important role for public investment and public goods, in such things as counter-malaria, counter-AIDS, education, public health, etc. - but without the engine of trade and markets, Africa will at best remain the world's begging bowl.

Sometimes I wonder why someone so obviously brilliant as Sachs would move in this kind of direction, against strong evidence over decades. Unlike many of his confreres in international organizations, he is not simply a reactionary socialist under an "internationalist" label. It seems to me that a certain amount of it reflects the impatience of an aging - and, let's be honest, massively egotistical - man who wants to see it happen in his lifetime - does not want to accept that the better path will take longer than he himself has got. After all, Easterly's fundamental intellectual point is that development of the kind that Sachs today advocates is essentially a strategic endeavor - one that aims to move massive amounts of money in a short period of time at the macro-level.

Whereas the fundamental problems of poverty reduction for the very poor of the world are at the micro-level. They are today tactical rather than strategic - the resources at the level of global grand strategy have been repeatedly deployed over the last few decades, but they are derailed over and over again by failures at the tactical level, at the end user, last mile (or two or three) level - through corruption, failure to follow through at the village or city level, etc. And those problems have to be addressed individually, at the retail rather than wholesale level. They have to be addressed at the level of political society, which means at a minimum the level of nation-states as well as more local levels. Which means time and more time: this is not a recipe for inaction or complacence, but for long term attention to the task at the microlevel.

Or, to put it quite a different way, Sachs, Bono, all the rest, propose to be the Wilberforce of our time. I applaud this, quite sincerely. I was profoundly moved a couple of weeks ago to see the portrait of Wilberforce in Britain's National Portrait Gallery, as well as a large scale painting of one of the founding meetings of the anti-slavery society in Britain. But what Andrew Mwenda says (interpolating freely my own views into his lines) is that growth in Africa means that its people must eventually be drawn into the global market and become "ordinary" producers and consumers in that market - whereas the most that the Wilberforce moralizing approach will accomplish for economic development in Africa is the begging bowl. Economic growth can, and should, be conceived at one level as a Wilbeforcean moral cause for Africa, but slavery and the slave trade also have certain great dissimilarities with economic growth and poverty reduction, not the least of which is that at some point, the begging bowl must end and "ordinary" market relations obtain - and under some circumstances, attachment to the former can tragically forestall the latter. The two need not be at odds - the model of public investment in vital public goods, for example, while building the connections of trade and markets that produce "ordinary" production and consumption - but they can become so.

Sebastian Mallaby on the World Bank and Wolfowitz

Sebastian Mallaby is very smart, and there are few people on the outside more knowledgeable about the World Bank than he, so this column from the Washington Post, Monday, May 14, 2007, A14, is must-reading. As is his 2004 book, The World's Banker: A Story of Failed States, Financial Crises, and the Wealth and Poverty of Nations. Mallaby is a hard-headed, tough-minded journalist and policy analyst in the area of development and global poverty reduction, one of the smartest and best informed outsiders.

Sebastian - I know him a little bit - appears to have been reacting in his WP column to this George F. Will column, also in the Washington Post. Will is not an expert on the Bank or international development; his column appears to have been written after some discussion with one or more of the Bank's critics. Mallaby appears to be out to marshall a lot of facts about the Bank and its work that Will and his readers are not likely to know much, if anything, about.

In taking down Will's column, however, Mallaby sacrifices a lot of legitimate criticism and the possibility of radically rethinking the Bank - radical criticism that he himself is much more willing to consider in his book. I understand that an 800 word column does not allow much room for subtlety. Still, that acknowledged, I don't quite think the column admits what Mallaby himself otherwise would say about the shortcomings in the Bank's business model. I fear that in this column, Mallaby is, alas, simply channeling the Bank.

(I leave aside as unserious the column's opening argument that one can look at the Bank simply like any other company and therefore the board of directors should fire Wolfowitz for having lost their confidence and having lowered share price. The remainder of the column, after all, is one long argument as to why the Bank cannot be treated merely as any private company. If it were a private company, after all, well, it wouldn't exist. As to the bizarre analogy to falling share price, it is inapposite not just because the Bank doesn't have one - rather, the larger point of the remainder of the article is that the Bank cannot, by definition, be measured according to such criteria. It is nearly as idle as the analogy sometimes bandied that US voters are "shareholders" who should fire Bush as "company president.")

Mallaby points out that approximately half of the Bank's outflows last year went to poor(er) countries if one includes, as properly one must, the Bank's soft loans and grants programs - these being the general evolutionary trend of the Bank. This is his main point of attack against the Will column; the (almost certainly correct) dangling implication is that Will has no idea about this. There is, in other words, a story beyond the statistic Will cites that 27 middle income countries received 90% of the regular lending of the Bank.

Fair enough. But one might conclude that this is precisely this statistic that should cause one to wonder why the Bank exists as a bank. Sebastian defends the middle income lending - which, after all, still amounts to over half the Bank's outflows - with the throwaway line that much of it goes to countries like China or Brazil that have many, many poor people. Sure, but how that regular lending really, genuinely, measurably affects outcomes for those very poor people is very murky - perhaps someone more expert than I can explain it, but I haven't seen measurable data to that effect - in large part because of the question of what role it plays in countries that do indeed have access to private capital that far exceeds the capital flows of the Bank.

It is far from clear, at least to me, that such regular lending to middle income countries has positive longterm impacts for the very poor of those countries. In part this is because money is fungible. In order to demonstrate that these funds make a difference to these poor people, it is not enough to show that it increased aggregate capital flows. It is not even enough to show that it was, in the first instance, specifically targeted toward those poor people - because, after all, the inflow of Bank funds, might simply have allowed other funds to be siphoned away. Anyway, the incentives from a financial statement point of view for the Bank to want to make loans to those safe middle income countries is a strong reason at least to wonder what the economic benefit is for the very poor in Bank lending to middle income countries and to want to see strong, reliable evidence for it. Perhaps it is there and, although I do tend to follow this literature, perhaps I have simply missed it - and Sebastian knows this literature, I'm sure, as well or better than anyone, so I would be happy to be pointed toward the papers on SSRN or elsewhere.

But assume for a moment, arguendo, that the criticism I make above about middle income lending is so. In that case, Mallaby's argument falls back on the fact that slightly less than half of the Bank's outflows come in the form of soft loans and grants. But that fact is lukewarm at best and really cuts both ways. The argument radical reformers of the Bank make is that there is little reason why the Bank should not be reorganized to give up the private capital market-intermediation-subsidized lending to middle income countries altogether, and focus entirely on the soft loan-grant programs, to the poorest countries. Of course private capital markets cannot do everything, as Mallaby says - but that is not the argument that the radical reformers make and is surely a straw man.

The problem of the Bank qua bank is that it seeks to intermediate private capital markets (with a subsidy), to try and do precisely what Mallaby suggests private capital markets cannot do because capital markets cannot solve all of poverty's problems. The reformers would suggest that the subsidy in the case of the Bank's ordinary lending to middle income countries is not really enough to compete with the functioning of the private markets; the Bank's lending really is a fifth wheel, and it should give that up in favor of activities for which it is not merely a fifth wheel. (As for crisis lending to middle income countries that Mallaby mentions, well, what is the IMF for? And - I don't know the answer to this - how great was the role of the World Bank in liquidity terms in the Asian crisis compared to the Fed?)

In the case of the poorest countries, however, lack of capital is genuinely an issue. So is the ability to repay any loan. So is technical assistance, and so is any improvement in governance. Why not cause the Bank, therefore, reorganize without the middle-income country intermediation-banking function, and focus solely on soft loans/grants and, let us not forget, technical assistance and governance advising. And focus on countries, societies, that are the poorest. Why endorse half measures?

For if that's what the real value added is, it is far from clear why anyone needs the Bank's goldplated operations -they cost what they cost in part because they are designed to interface with the private capital markets, and to pay the people who do those functions a respectable civil servant salary commensurate with financial professionals in the public sector. In my experience, it is not what one would pay program officers in a foundation dealing with local poverty matters on a grant-making basis, who do not have and do not need the banking credentials on which the Bank prides itself. There are comparably serious skill sets that these anti-poverty program officers need, yes, but frankly they can be obtained at a lower cost, in part because they are not so readily placeable in the private sector. Why not reorganize at a cheaper cost along the lines of far more efficient, far more locally oriented (because less capital markets oriented), far cheaper in terms of transaction costs European aid agencies? (I do not suggest under any circumstances modelling anything on US AID, which is a waste of oxygen.)

If these functions were being carried out by the Dutch, the Swedes, the Norwegians, the Swiss, through their national development aid agencies, how would they do it and what would they pay? Would they pay for a whole banking staff when in fact the operation is aimed at grantmaking anyway, and the money would come from governments in any case, not from the capital markets and relent at a subsidized interest rate? They would - they do - engage in a certain amount of on-lending in which they really do expect to get repaid, but that is far from being the core, let alone over half, of their work.

Why, in other words, should the World Bank continue simply for historical reasons as a bank, a bank designed in cost structure, skill sets, etc., to interface with private capital markets? Why share the pleasure Mallaby takes in noting that slightly under half the bank's outlays went to soft loans and grants - why not think those things should essentially be the whole thing? Why take pride in half-measures that continue precisely the sins that Sebastian correctly sees in thinking that it all can all be done by capital markets? Why not sever the relationship to the capital markets altogether and concentrate on poverty reduction as such?

(ps. The column also mentions in passing that Bank salaries, once you take into the account the tax adjustment and long summer vacations, are comparable to academic salaries. I'm told there is a link to a paper by an economics professor in the online version, which I will look up. But as someone who is a college professor, and who is married to someone who used to work in an international organization with similar salary structures and arrangements and who, hence, paid very close attention to comparative salary issues - well, at least if you were not an American and not subject to tax on your salary, it was a very favorable deal. The tax break was amazing for non-Americans. I simply don't understand what Mallaby is suggesting here - it is not our experience at all. As for summer vacations - every dean and professor I know understand perfectly that summer vacation is simply the research semester, it's not vacation, at least if you plan on getting tenure, getting a promotion, getting a raise. It's a 12 month job like any other. And now I have to get back to it.)

(pps. Or consider this short op ed by AEI resident scholar Desmond Lachman, here. It argues for a World Bank that gives up the middle income lending function altogether, along with the proliferating mandates at the Bank that increase its unaccountability.)

Two recent articles on microfinance and the Yunus Nobel Prize

The Nobel Peace Prize will be awarded to Muhamad Yunus for his work with Grameen Bank in microfinance this coming Sunday in Oslo. I've already said some stuff about this, in an earlier post when the award was announced, here. But here are two recent articles on Yunus and microfinance, this one from the New Republic, and this one from the New Yorker (which also covers the borader topic of venture philanthropy).

Unfortunately I don't have time now to comment on them, although I think they are each problematic in different ways. I'm in the middle of a survey of recent books on microfinance to write a review for the Times Literary Supplement in January, and then a longer, academic review essay later on - it's a lot of reading. The last time I went through the technical literature systematically was back in 2002 around the time I was writing this article on microfinance and globalization, and there has been a huge increase since. Most interesting to me has been the entrance of formal economics into the field. Maybe I'll try to make some comments on all this, but in the meantime, congratulations to Mr. Yunus.

***
Why Nobel laureate Mohammed Yunus will doom microfinance.

Poor Vision

by Andrew Curry

Only at TNR Online
Post date: 12.07.06

By now, Mohammed Yunus's first loan--$27 from his pocket to a group of bamboo furniture makers in a Bangladeshi village--is a legend in the international aid community. Inspired by the results of his modest 1974 experiment, Yunus, an economist, went on to found the Grameen Bank, which today provides millions of Bangladesh's poorest with life-changing access to credit.
Yunus will be awarded a Nobel Peace Prize for his work this Sunday in Stockholm. The honor is proof that small-scale lending to "the bottom of the pyramid"--or so-called "microfinance"--has become the hottest idea for solving poverty to hit the development community in decades. But following Yunus's vision is the best way to doom a promising movement to failure.

The problem isn't Grameen's size or its borrowers, but its philosophy: Yunus is firmly anti-profit. "Maybe banks can make a profit from [loaning money to the poor]. ... But this is what loan sharks do," Yunus said after his Nobel win was announced in October. "We have enough enterprises generating money for profit. I would rather think that the rich can set up social enterprises." Yunus even objects to the term "microfinance," preferring the profit-neutral "microcredit."

This principled allergy to profiting from the poor may be part of the reason why Grameen still depends on NGO grants and its founder's incredible charisma to stay afloat. Indeed, Grameen is glorified philanthropy, not banking. If small-scale financial services are to be a long-term solution to the problem of poverty, they need to embrace profit.

The reasons lie in the realities of lending. Though Grameen and others have convincingly dispelled the notion that the poor are bad credit risks--Grameen's reported repayment rate is close to 99 percent, comparable to that of most commercial banks--microfinance still poses huge challenges. Big banks have traditionally shied away from loaning to tiny customers, because doing business on such a small scale is very expensive. Since small-scale borrowers are often illiterate, with little or no collateral and primitive or nonexistent bookkeeping, evaluating their creditworthiness is a labor-intensive process.

Take the case of Serbia's sole microfinance bank, ProCredit Bank Serbia. The bank's 330 loan officers visit two or three clients a day. Loans are evaluated based on business plans and capital, but personal behavior and family reputation can be equally significant. "These businesses don't have books--this isn't a corporation," says ProCredit Serbia executive board member and former loan officer Mirjana Zakanji. "We have to assess the potential of the owner of the business, because they're also the main employee." Eighty percent of the bank's 7,000 new loans each month are for less than $12,500. (The European Bank for Reconstruction and Development defines microcredit as any loan under $38,500.)

Given the intense--even holistic--work involved in each micro-loan, it's not hard to see why most banks would rather issue a single loan of $1,000,000 than, say, 10,000 loans of $100. Yet microfinance banks around the world have managed to turn lending to the poor into a profitable, sustainable business in the last decade, even at the very smallest loan levels. ProCredit Bank Serbia's German parent, ProCredit Holdings, has profitable branches in Haiti, Congo, Angola, and El Salvador. Indonesia's state-owned, commercial Bank Rakyat started offering micro-loans in 1984. Today, its smallest micro-loan unit has over 700,000 clients and turns a profit, despite a $33 loan average.

How can loans so small make money? Microfinance banks are forced to charge high interest rates just to cover costs--and even more to make a profit. In a study of South American microfinance banks published in April, Harvard Business School professor Michael Chu found interest rates ranging from 21.76 percent at Bolivia's Asofin to 87.5 percent at Mexico's Compartamos. In India, microfinance banks typically charge at least 30 percent a year.
Compared with Grameen's rates (between 10 and 20 percent per year, about what Americans pay for their credit cards), that's high. And that's what bothers Yunus. High interest rates have drawn increasing fire from other quarters, as well, with the spread of micro-lending. Last year, Indian officials used a spate of rural suicides as an excuse to shut down microfinance bank branches and threaten interest rate caps of 10 percent, a level that would put most of the country's microlenders out of business.

But the profit motive isn't necessarily bad for poor borrowers. Profit breeds competition, which in turn lowers interest rates, as microfinance banks compete for clients. In markets where multiple banks have gotten into the microfinance business, interest rates have dropped significantly, and the banks have grown. Chu cites Bolivia's example. When the first micro-lender opened there in 1992, it charged 35 percent interest. Intense competition in the years since has driven the average interest rate down to 21.23 percent, South America's lowest.

"There are all kinds of prejudices and value judgments when you talk about profits and the poor," says Chu. "Those are just knee-jerk reactions. The prejudice against profit is a judgment made by emotion, not efficacy." And for-profit microfinance banks are still a bargain when compared to the only other option available in many parts of the world: traditional moneylenders and loan sharks, who normally charge 10 to 30 percent interest per month, or more than 1,000 percent per year.

Moreover, if financial services to the poor are to grow, they need to be able to do more than cover costs. When microfinance banks make money, they earn the capital necessary to expand, making more credit available to more people. And, whereas Grameen's transparency leaves much to be desired, commercial banks are held to a higher standard of accountability. "To develop this type of business to a high level, it needs to be financially stable and sustainable," says ProCredit Serbia's Zakanji. "There are thousands of NGOs rushing around the world without clear goals. Commercial institutions with demanding shareholders will be more successful in the long term than most of these guys." Indeed, after three decades, the sector is finally on the verge of becoming an attractive investment. In the last year, major funds like TIAA-CREF and banks like Citigroup have announced plans to invest in microfinance operations.

That's why the worst thing that could happen at this stage is for profitable banks to be undercut by subsidized competitors like Grameen. To be sure, it may be difficult for some commercial banks to reach the "poorest of the poor," as Grameen does. Banks like ProCredit serve mainly micro-entrepreneurs, poor people with skills or businesses who need capital to grow or stand alone. But, any financial institution--even Grameen--requires that borrowers pay the money back, with interest. A strong case can be made that, instead of taking on debt, the truly destitute will always need the help of charities.

There's no doubt Yunus deserves his prize. His work has been instrumental in changing the lives of the poor in Bangladesh, and his success has given the microlending effort invaluable credibility all over the world. But, while Yunus has described his vision as a panacea for poverty, it's not a universal solution. If the idea is to succeed, the development community must set aside its distaste for profit and embrace the market.

Andrew Curry is a freelance writer in Berlin, Germany, and a former Fulbright journalism fellow.

Venture Philanthropy

The Skoll Centre for Social Entrepreneurship (Oxford University, Said School of Business) has published a working paper by researcher Rob John titled Venture Philanthropy: The evolution of high engagement philanthropy in Europe (June 2006). It does not seem to be available online (which is strange). The Media Development Loan Fund (MDLF), from whose board meeting I am now returning home, is one of the case studies featured in the paper.

The paper defines venture philanthropy as providing a “blend of performance based development finance and professional services to social purpose organizations … analogous to the practices of venture capital in building the commercial value of companies.” That definition seems pretty good to me. The movement toward venture philanthropy arises largely in the United States and in particular from venture capitalists seeking to apply not only their fortunes but their methods into philanthropy and charitable organizations.

One important issue in venture philanthropy is whether it seeks to apply these methods of venture capital merely by analogy or in fact. Meaning, when venture philanthropists fund an organization, do they seek to apply venture capital methods of assessing return to calculate a “social return” on investment that is analogous to private equity’s return on investment, or do they intend to invest in that (relatively narrow) range of charitable activities that can actually generate a genuine return, to then be recycled – as in microfinance sometimes, though not very often – back into the charitable activity?

There are some areas of charitable activity that actually generate revenues, of course. Education, higher education especially, is one. Health care, eg nonprofit hospitals, is another. These are two leading areas in which fees by users of the nonprofit services are expected ordinarily to cover costs of doing business. Microfinance sometimes, though not very often, can generate a return on investment – and in a wider range of cases if one excludes from inclusion in recovery of costs foreign organizations that provide set-up funds and background services, in order to focus on the recycling of funds. There are some other areas, such as community economic development, where real estate developments and small business development can generate revenues that – again, often using a deliberately narrowed definition of costs to be recovered – can generate a return on investment. (You can either include all the background costs in the amount to be recovered as capital investment against revenues, in which case your rate of return is actually a rate of loss, but you can still measure how small the rate of loss is as against other things. Alternatively you can exclude certain costs from the amounts to be recovered and have a positive rate of return, although not one that captures the full implicit subsidy.)

MDLF invests in private media businesses in the developing world, with the social and charitable mission of promoting independent media around the world that provides populations with access to objective news and information. It invests in newspapers, radio, TV, and new media such as internet, and ancillary businesses such as printing presses. It is a paradigmatic case of venture philanthropy actually seeking a real rate of return, not simply trying to measure social return. Because it undertakes regular commercial investment in private businesses, it seeks to recycle its funds and increase its actual commercial portfolio. This is the consequence of a very special charitable mission – the propositions that editorial independence of independent, objective, news-providing is an important feature of a liberal democratic society, and that the best way to achieve that editorial independence is by financial independence of the media company. (Something similar operates in community economic development – a condition of a socially healthy neighborhood is small business ownership and the investment of local individuals in local housing, real estate, etc., thus justifying the investment of charitable organization funds into commercial businesses as a charitable end in itself.)

As a consequence of investing in commercial ventures that have the possibility of generating a return on charitable investment, however, the relationship of MDLF to sources of capital is potentially different. It is able to mobilize a special source of funds within the so-called “non profit capital market” of donor, foundation, philanthropic funds – loaned funds, so-called (originally in the tax law but now a widely used term) “program related investments” in which a foundation lends sizable funds to MDLF, expecting repayment and (below market) interest. MDLF then on-lends those funds – also technically program-related investments. (MDLF, it turns out, is the largest maker of program related investments among all US charities, which astonished me, but apparently this has been true for years.)

Is it also able to mobilize, on account of its ability to generate returns, funds from genuinely commercial sources – the real capital markets, in other words? Well, yes and no. The difficulty is that MDLF’s rate of return on its investments in its clients – all told, all costs in, including the costs of capital, administration, and monitoring of its portfolio – does not fully cover its costs. The interest rates it charges are themselves below local market, and insufficient to cover MDLF’s own costs fully. So in that sense, without access to grant funds from the nonprofit capital market to subsidize its operations and administration, if it sought all its funds in the commercial markets, it would eventually go out of business because its all-in cost of funds would be below the all-in rate of return on its portfolio.

On the other hand, MDLF has made landmark entry into the commercial capital markets. It has entered the US commercial markets through the “socially responsible investor” market – offering, through the SRI Calvert Fund, “press freedom notes.” Here. Essentially, investors can buy the press freedom notes and accept a lower than market return on them. So far MDLF has not sold a vast amount of these notes, which typically are marketed toward the middle income investor in the US who is willing to forgo a certain amount of return that might be had on a purely commercial note.

But MDLF has also done this year a first-ever deal in Switzerland. MDLF is, I am pretty sure, the first nonprofit to have issued a derivative security that is publicly traded on the Zurich stock exchange. You can read more about it here and watch its trading history on the market. The derivative is a genuine landmark in nonprofit finance – and owes much to MDLF’s own (quite remarkable) staff – working with a new and highly, highly innovative SRI organization in Europe, ResponsAbilite. They partnered with a leading Geneva private bank, Vontobel, to create the derivative. Eventually, the Swiss government development agency joined the effort, offering a guarantee on a part of the security. But of course a good question is why a nonprofit would seek commercial market access if the cost of capital would turn out to be higher than its rate of return. Well, two answers. One is that the cost of capital on these instruments is still within the SRI model – commercial in one sense but still subsidized in another, including the Swiss government guarantee and a SRI cost of funds (one percent) to MDLF. The other, however, is that circumstances could arise in which commercial funds might be attractive for particular projects where investment requirements simply outstrip available funds in the nonprofit market. (Much of MDLF’s loan pool comes from European aid agencies, such as SIDA.)

But this is all, well, finance finance. It is about real money and real returns. There is a portion of the nonprofit world for which that can make sense, and in fact it is wider than often appreciated. There are certainly ways in which, for example, investment in vaccine development – malaria, AIDS, etc. – can be about real rates of return because if someone can develop it, governments will provide a market ready to pay for it. The concept of venture philanthropy, however, is most interestingly and controversially applied in areas where it is necessarily by analogy – the concept of the “social return.” How do you measure that elusive thing? You can’t look on the Zurich stock market and track the price of your very cool, very innovative derivative security. The theory is very persuasive in the abstract. The problems of application make you wonder, though, how useful the concept can be at the microlevel. Can the theory generate a usable model?

The train is arriving in DC… so I will leave this here. Our board meeting dealt with issues of mission – what kind of media organizations should be supported with our limited funds, limited staff? Should an organization like ours adopt a global approach or should it seek to specialize in regions? And also real, live money issues, returns on investments, performance of our portfolio. Lots and lots and lots of numbers this weekend. Going closely over our audited financial statements. Going over reports by the finance director on portfolio performance. Discussions of financing mechanisms for new and old clients. M&A. Many of my students, I notice, who tell me they are interested in nonprofits and saving the world, somehow lose interest when it comes to numbers. Anyone who has worked very long in the nonprofit world will tell you, however, that numbers are critical for, well, everything. Likewise some minimum knowledge of accounting and finance. And as venture capital concepts take hold in the nonprofit world, those ways of thinking about the traditional charitable mission of saving the world become ever more important.

Muhammad Yunus wins Nobel Peace Prize for microfinance

Muhammad Yunus and the microfinance bank he founded, the Grameen Bank, today won the Nobel Peace Prize 2006. It was an award well deserved. I'm someone who does a lot of work in the microfinance and development finance area - I currently chair the board of the nonprofit media venture fund MDLF, which has emerged as financially the largest media assistance organization in the world - and like anyone else in the field, I have studied Grameen Bank closely and intensively. Yunus' contributions to the improvement of possibilities for poor have been very great, in large part because they point crucially in the direction of understanding the role of markets in improving the lives of the poor. Markets are not just for the benefit of the global middle classes and above. Indeed, the implications of his work for understanding the economic conditions of poverty have long made me think that he perhaps ought to have been awarded the economics Nobel (For that matter, I also thought that the Nobel prize in medicine ought to have been awarded to Heimlich of the Heimlich maneuver.)

My views on microfinance itself are somewhat complex, and are explored in an academic article from 2002 in the Yale Human Rights and Development Law Journal, here. It is a decent academic primer on the theoretical literature on microfinance, as well as expressing a somewhat complicated view about the relationship of microfinance to globalization and the global market system. There is some new, very good literature in the microfinance field, and I'll try to post about it later on.

So I applaud Yunus his Nobel Prize. Yet let me also add something important. I am not a starry-eyed worshipper of microfinance as a silver bullet in international development. If you read over my article, you'll see that I think has significant limitations. Some of them can be summarized as follows:

First, hard evidence that microcredit actually substantially shifts longterm household outcomes is not as easy to come by as you might think or hope. I strongly think it is in fact true, but if asked to show hard data to prove it, that task is much more difficult than you might have thought. And for ripple effects on whole communities, the hard data task is that much more difficult. The often-touted repayment rate is some indication of success of the program, but it is mostly an indicator of the success - survival, really - of the lending institution. It is not directly a measure of improvement of longterm household income.

Second, Grameen bank itself is not really a model of what microfinance has been said to mean among the most enthusiastic - the poor bootstrapping themselves out of poverty. The bank itself receives various subsidies, including indirectly from the Bangladeshi government. Moreover, the bank is one of the least transparent financial institutions I have ever studied. And the whole sector of microfinance worldwide is and has to be massively subsidized. That is not going to change - nor should it. The measurement of microfinance's success is not the fact that it requires subsidies, but that it produces outcomes exceeding those of any other available social investment policy at the household and community level.

Third, the microfinance model is gradually coming to be seen less as an income generation mechanism on its own - it is unlikely that it generates that much revenue - than as a technical training program to bring poor people into the market economy. As a financial resource, it is extraordinarily labor intensive; the repayment rates are impressive, but they do not take into account the monitoring costs that such repayment rates seem worldwide to require in microfinance - and when those transaction costs are taken into account, the business model requires massive subsidies. Those subsidies can be justified, but largely as a training and educational tool, not as finance. (This is counterintuitive, and very hard to do in practice - essentially operating as a genuine business, and requiring market discipline even within your subsidized environment, while at the same time being aware (sort of at the meta-level) that fundamentally your contribution is as much or more technical knowledge and assistance to people without real experience of money, markets, and credit institutions. It is hard to maintain business discipline institutionally if you know somewhere in the back of your mind that you are also, or mostly, an species of training or educational institution - it produces a difficult mismatch of expectations within NGO mission terms.)

Fourth, although in the first decades of microfinance, the vision was one of the poor financing themselves out of poverty with, essentially, seed capital, it is now widely acknowledged that it must go hand in hand with public investments in public goods - health, education, and so on. Those goals tend to reinforce microfinance and viceversa, but essentially as consciousness raising tools to persuade people of the value of those public goods, such as education, especially for girls who would otherwise be left out.

Fifth, microfinance does not really address the problems of the "poorest of the poor" - it is really about the poor, rather than the really, really poor. This is something now acknowledged pretty much across the board. The poorest of the poor tend to live in areas of high insecurity and failed states - and in those places, it is practically impossible to run a microfinance program, or any other form of investment, public or private. I am a huge fan, and practitioner, in the microfinance area, but it is not a silver bullet.

Sixth, the whole microfinance as women's development is somewhat oversold to credulous, on the one hand, and ideological, on the other, Western aid agencies with agendas, and in part is an artefact of those Western agendas. The utility of focus on women's empowerment is true in part, but much less so - much less universal - than prevalent ideology would suggest - and there is a gradual recognition that it is better in many situations to focus on households rather than women as such as the micro-development unit. At the same time, it is no accident that Grameen Bank and its projects have been targets of Islamist violence in Bangladesh, because of their identification with women's empowerment.

Seventh, it is not always clear in particular circumstances whether microfinance is about drawing poor people upwards into the global market (and simultaneously the market down to them), or whether it is about creating a permanently subsidized, "faux" market that never really draws the poor into the larger economy beyond that created by NGO funding itself. One has to look case by case to see what the economic interconnections are. (I discuss this in much greater depth in my Yale article.)

One could make other critiques, but this is enough to indicate a certain caution about overselling the idea.

But - and this is a big but - all that said by way of caution, let's please not lose sight of the forest for the trees. The big picture - the one that justified the Nobel Peace Prize - is the recognition that markets matter to poor people too. That they have to be drawn into globalization. That the worst thing is, as (of all people) Kofi Annan said, back in 2000, the problem is not globalization, but those who are left out of globalization, those with no skills or anything of any use to contribute. The condition of the world's poorest people is not one of exploitation, in the old fashioned marxist sense - if it were, the world's poor would have something with which to bargain. On the contrary, the tragedy of the world's poorest people, especially, is that they are genuinely surplus. They are too poor to even be worth exploiting.

And surplus in the ugliest way - looking at Africa, for example, I would say that secret wish of the world's bourgeosie is not that Africa get richer, but that somehow Africa would be (humanely, of course) depopulated and turned into one big game park and environmental preserve. Of course, we don't want anything bad to happen to all those poor people - but if they suddenly just somehow hadn't ever existed, really, wouldn't that have been the best thing? That's what I mean by describing them as superfluous, surplus population.

Microfinance in the very large picture of things is one of those ideas that helps bring poor people into the market, to find a place in the market, rather than being part of the superfluous population of the world - people less valuable, apparently, than cheetahs. It is not the only idea in this vein - Hernan de Soto's views on property rights and collateral, for example, are another - sure, they aren't the only thing, and evidence suggests that that concept, too, has been oversold (the Economist recently had a story on exaclty that). So is the broad concept that Wolfowitz for a while was attempting to push at the World Bank, until the European socialist globalcrats overrode him - that the problem in the developing world in the first place is governance, because without it, public or private investment is bound to fail.

This cluster of ideas about drawing poor people into the world's economic platform is fantastically important, if only to get us beyond the dirigiste, global socialist concept of international development as simply shoveling money that never seems to accomplish its purposes. That's the point - no, of course it never works out as well as promised in theory, and it has real limitations, but don't lose sight of the larger picture - the one for which Yunus deserves the prize. And the fact that he comes to it from the subcontinent's Left is only all the better; he is not a neo-liberal, far from it.

A few relatively new microfinance readings: Beatriz Armendariz de Aghion and Jonathan Morduch, The Economics of Microfinance (MIT Press 2005), absolutely superb; David Hulme, Microfinance: A Reader (Routledge, 2006, costs a fortune), coming out end of October 2006, haven't seen it yet; and Joanna Ledgerwood and Victoria White, Transforming Microfinance Institutions (World Bank 2006), essential practical how-to manual for institutions, but also a great introduction.

(As a side note. There has been some discussion over at Opinio Juris and other places about the curriculum for teaching international economic law. I have taught international business transactions and other international economic law courses for a long time, now, and I find that I am able to usefully integrate many of the international development transactions that I actively do in the development finance area in the course of my pro bono practice into my IBT teaching. Lending transactions, equity deals, joint ventures, letters of credit, services agreements, licensing, etc. - teaching as I do an IBT class that focuses exclusively on transactions (at our school, we make trade a separate intro class, which I think is extremely sensible), I find development transactions both interesting for students and, in some ways, helpful teaching tools because of the fact that these transactions often involve signficant risks, political and legal risks that are obvious to beginning students in ways that risks in developed country transactions are not. Here is a link to my 2005 IBT final exam, involving post-war reconstruction in Africa, conflict diamonds, and other things.)