Finance in the Third World

PHNOM PENH, Cambodia — Maddox Jolie-Pitt and landmines. That was pretty much the extent of my knowledge about this exotic Southeast Asian country before I arrived. Now, after living here, working in the microfinance industry, and traveling extensively throughout the provinces, I feel a deep connection with the people and the history of Cambodia. The tragic history of the Cambodian people is not far beneath the surface of everyday life. In the taxi on the way to my hotel on my first night in Cambodia, I conversed with my driver about life in Cambodia, the best places to eat, and, of course, where to have a good time. After enthusiastically answering my questions and giving me recommendations on a slew of sketchy nightclubs, I changed the subject to his family. From his change in demeanor, I knew I had touched on a sensitive subject. He replied that both his parents were killed by the Khmer Rouge. Although I was familiar with the reign of Pol Pot and knew that millions had died under his regime, the temporal proximity was surprising to me. Only a generation ago in Cambodia, almost a fifth of its citizens were killed. Now, after years of political and economic instability resulting from corrupt politics and the Asian financial crisis of the late 90s, Cambodia is growing, its people are healing, and Westerners are arriving. That is where I fit in. Like many other young and idealistic Harvard freshman, I am using this summer as a time to test the waters of the “real world,” trying to make it a better place with everything that I’ve learned at Harvard. That is why I chose to work at a microfinance institution (MFI) in Cambodia. For many people, microfinance has philanthropic connotations because of its focus on the world’s poorest. This is not a completely inaccurate depiction, as it does offer many options for the poor that they have never previously had. However, microfinance at its core is more reliant on the agency of the poor than on the philanthropy of those in the industry. Microfinance is about empowerment and giving the poor a chance to survive, but as the saying goes, “There is no such thing as a free lunch.” Because of the misconception that microcredit is based in philanthropy, some of its lending practices have become lightning rods for debate. In the past few years, a number of MFIs were the focus of criticism after charging their clients extremely high annual interest rates. In perhaps the most famous case, Banco Compartamos of Mexico was found to be charging a rate of over 100% on loans to their customers. In Cambodia, the annual interest rates are somewhere between 30% and 40%, which is still very large. As an outsider, these number may suggest that the banks are stealing from the poor to give to the rich, but a number of factors necessitate these high rates. The loans are risky, and the banks spend a lot on operating costs to distribute loans to peasants fanned out across the countryside. So even though the interest rates may seem exorbitant to an outsider, the margin of profit can be very slim for the banks. Another misconception about microfinance is that the clients of microfinance banks are escaping from poverty. My coworkers and I made attempts to find success stories among the beneficiaries of the numerous loans that our bank had distributed. We harbored hope that we could find one borrower who had created a successful or innovative business. After much time spent searching, not one success story could be found. The reason for that, I came to discover, is not because the Cambodian people lack creativity or because they are wasting their money on frivolous things. It is a matter of what is possible for these people. Cambodia lacks the infrastructure and technological capabilities at the moment to make most businesses feasible. Cambodia is growing, but it is far behind even its closest neighbors, Thailand and Vietnam. As domestic and foreign direct investment modernize the country, the loans of MFIs will surely be utilized in more creative ways. Microfinance does have its merits. It provides one of the only means for women in certain societies to establish a self-sufficient lifestyle. It is also overwhelmingly used to the benefit of both men and women as the only way to provide income stability. For instance, sickness or drought can dramatically disrupt the work cycle of people living on less than a dollar a day, and microcredit can provide a respite, allowing people time to regain their health or weather climate fluctuations without starving. At this moment, access to credit is the most important boon of microfinance, regardless of whether the interest rate is high or low. Change is occurring. Interest rates have been falling with competition innovation in the industry. The Kiva organization allows people in countries such as the United States to lend money to certain banks in developing countries. Lenders don’t receive any interest on their loans, so this type of funding is less expensive than borrowing from a commercial bank or an NGO. Any student who has taken N. Gregory Mankiw’s course or read his textbook can tell you that if you allow markets to operate freely, new firms will enter the market and drive down profits and prices until supply equals demand. Even in developing countries today, we see that principle in action as new banks are entering the market and offering lower interest rates. If this continues and the operational costs decrease as technology increases, interest rates could fall to levels as low as in the United States. The microfinance industry is an excellent way to learn about extreme poverty, an issue that today affects around three billion people all over the world. It is nearly impossible to come to grips with this issue by just looking at it from an academic perspective. It is important to see it firsthand. Working in Cambodia opened my eyes and taught me that microfinance is not a panacea for global poverty but rather a respite. No obvious solution to the problem exists, but it is a problem that I am confident can be ameliorated by our generation. —Charles LaCalle, a Crimson business editor, is a government concentrator in Kirkland House.