Veronica Pugin

While small business development is not limited to microfinance, microfinance is often credited for providing the seed capital for micro-businesses to grow. With 1,974 microfinance institutions (MFIs) globally signed up with MIX Market (the number one source of financial and social performance data on MFIs) serving 91.8 million microcredit borrowers as of 2009, the microfinance industry’s financial services are broad and varied, yet the most fundamental service has been microcredit (also known as microloans) to the poor who are traditionally rejected by banks.

The theory of microcredit is that the poor can invest this small loan into starting or growing a small business to increase their family income and ultimately raise their family out of poverty. While the theory of microcredit is logical, there is little proof of its ability to eradicate poverty. Since the 2008 Innovations for Poverty Action/Financial Access Initiative Microfinance Research conference, the effects of a simple microcredit have been under serious question as they lack proof and evaluation.

For a microcredit to actually promote poverty eradication, it must lead to business growth for the owner in order to increase revenue and ultimately increase the family income. Based on the Needs Assessment we completed with over 250 small business owners in Santiago, Chile, we noted that significant enough business growth to remove them out of poverty is often times not achieved for a number of reasons such as a lack of business training, a lack of a business plan, family emergencies, formalization barriers, etc.

The most striking obstacle to business growth noted was the business owners’ struggle for market access. Not only does this revelation provide valuable insight for learning about the challenges of small business owners in the developing world, but it also reveals a fundamental limitation of microcredit working on its own.

Lack of Market Access

The idea of microcredit is that using the loan the small business owners will be able to ultimately sell more products or for a higher price in order to increase revenues. This works under the assumption that there is enough demand in the market to absorb the new or improved products. The most important reality that challenges this assumption is the fact that much of the developing world’s cities are divided up by class, meaning that the poor all live together in a poor community, such as La Florida in Santiago, Chile.

What this means is that the small business owner is trying to increase their revenue in a community with little disposable income and as a result little demand for their product. Yes, they can increase their revenue in their own community, but it is unlikely that it will be to the level that is needed to overcome poverty. The gravity of the issue is that microcredit is often done on a massive-scale utilizing group-lending. This leads to the community of the poor simply tossing around the few dollars worth of cash around to each other, never actually accumulating new wealth. The opportunities for these small business owners lie outside of their community, in areas with more money to be spent on their products. Why don’t they access these new markets? This expansion holds a price tag and risk factor that is too high for even microcredit to cover most of the time. What ensues is a cycle of poverty at the community level that can only be broken by branching out.  

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