Monday, March 19, 2012

Screwing over the world's poor

Yes, I know that Dr. Yunus the founder of the Grameen Bank won the Noble Peace Prize in 2006.  I even mentioned his institution during my introduction of Elegant Technology to the 1993 meeting of the American Economic Association when I said, "During the campaign, Bill Clinton spoke glowingly about the microlending practices of the Grameen Bank in Bangladesh."  I was quite appaled by this adding, "That we should need ideas from such a source says much."

So why was I so horrified by this praise for a third-world loan shark?  Simple.  The idea that a pitifully poor population could support a bunch of enterprises that had a 13+% nut to make was mathematically preposterous.  As any Producer can tell you, while getting your hands on the necessary capital to get a new product or service to market is a significant problem, it is not nearly the problem of finding paying customers for your new enterprise—especially if your potential customers are already extremely poor.  This was always the fatal flaw of "supply-side" economics.  Unlike the bizarre teachings of Jean-Baptiste Say, supply does NOT create its own demand.  Disproving this fallacy was central to the 1936 writings of John M. Keynes in his General Theory.

Microfinance would only work if usury suddenly became a LOT less harmful and Say was suddenly proven correct.  What could possibly go wrong?  Turns out, quite a lot.

Marred by Wall Street-Style Greed, Profiteering, Client Abuse, and Market Chaos
The Microfinance Delusion

Thirty years ago, it was widely thought that the perfect solution to unemployment and poverty in developing countries had been found in the shape of microfinance, the provision of tiny microloans used by the poor to establish an income-generating activity. Microfinance is most closely associated with the US trained Bangladeshi economist and 2006 Nobel Peace Prize recipient, Dr Muhammad Yunus. By celebrating self-help and individual entrepreneurship, and by implicitly discrediting all forms of collective effort, such as trade unions, social movements, cooperatives, public spending, a pro-poor ‘developmental state’ and – most of all – collective moves to ensure a more equitable redistribution of wealth and power, neoliberal policy-makers in the international development community fell in love with microfinance. The World Bank, USAID and other agencies began to aggressively push forward the concept and, in order to reduce the need for subsidies, also insisted microfinance be turned into a for-profit business. Microfinance soon became the international development community’s highest profile, most generously funded and supposedly most effective economic and social development policy.

Reality finally breaks through

Unfortunately, it is now clear that Yunus was wrong. The past 30 years has actually shown microfinance to be part of the problem holding back sustainable poverty reduction in developing countries, and not the solution.[1] Not only is there no solid evidence that microfinance has had a positive impact on the well-being of the poor,[2] since 1990 the microfinance sector has been increasingly marked out by spectacular levels of Wall Street-style greed, profiteering, client abuse, and market chaos.[3] It turns out that microfinance has largely been driven forward by nothing more than hype, PR, celebrity support, and a constant stream of faith-healing-like pronouncements from Yunus and his acolytes.

The problems with microfinance are deep and multi-faceted. First, right from the start it was assumed that no matter how many informal microenterprises were helped into life thanks to microfinance, sufficient local demand would always automatically arise to absorb this additional local supply of simple items and services. Yunus was clear on this. However, this understanding is fundamentally wrong: a local demand constraint does exist. Even in the 1970s, local communities in most developing countries were a hive of informal activity with most simple items and services pretty adequately provided by a community’s poor inhabitants. An artificially-induced increase in supply was thus always likely to generate very little benefit in terms of additional jobs and incomes. Instead, cramming more and more informal microenterprises into the same local economic space typically leads to ‘displacement’, where new microenterprises only survive by tapping into the local demand that up to then was supporting incumbent microenterprises.

Thanks to many new microenterprises, most of the hapless (and equally poor) individuals already struggling to survive in the microenterprise sector are faced with reduced turnover, leading to lower margins, wages and profits. Any employees might have to be dismissed. The additional supply also tends to depress the prices of the local goods and services in question, thus negatively affecting all (new and incumbent) microenterprises. In short, all too often microfinance results in promoting nothing more than an unproductive process of local ‘job churn’, with no real net employment, income or productivity improvements registered. Another way to look at it is that the existing community of poor micro-entrepreneurs are effectively being made to pay the price, in the form of lower incomes, for the few net jobs being created in the local community thanks to microfinance.[4] This is hardly fair and equitable.

Compounding the problem of displacement is the related problem of microenterprise failure. Even more than small or medium businesses, microenterprises are ‘poverty-push’ by nature, and so we tend to see a very high failure rate of such business units. This means into the longer term microfinance generates far less sustainable job creation than is typically thought. Failure also means the poor often experience the dangerous loss of important assets. Households first draw down family savings and divert remittance income to try to repay their microloan. If this is not enough, there is then the need to sell off important assets (often at fire-sale prices), such as equipment, machinery, motor vehicles, housing and land. On losing these assets, poor households all too often plunge into deeper, and often irretrievable, poverty. While the narrative of those supporting the microfinance movement (notably the World Bank’s neoliberal-inspired ‘Doing Business’ program) focuses upon maximising the ‘freedom’ and ‘opportunity’ to do business, this deliberately overlooks the negative outcomes associated with failure that are actually the main experience for the majority of the entrepreneurial poor.

In addition, the vast bulk of microfinance is not used to fuel microenterprise development, but actually goes to support simple consumption spending. Thanks to easy availability but with interest rates typically very high – one Mexican microfinance bank, Compartamos, charges its poor clients an annual interest rate of 195% – we increasingly find that the poor all too easily end up spending a large part of their incomes on interest repayments. This psychology also helps to account for the dramatic emergence of Ponzi-style dynamics in a growing number of developing countries, characterised by the poor gradually becoming trapped into accessing more new microloans simply to repay existing microloans. The most dramatic example of this destructive trend was in Andhra Pradesh state in India, a development that in 2010 eventually precipitated the collapse of almost its entire microfinance sector. more
Loan sharks ripping off the poor is an old, time-honored, tradition.  Using commodity futures to starve the poorest among us is new.  Not surprisingly, much of this innovation in human suffering comes courtesy of Goldman Sachs.
How Goldman gambled on starvation
Johann Hari   02 JULY 2010
Speculators set up a casino where the chips were the stomachs of millions. What does it say about our system that we can so casually inflict so much pain?

By now, you probably think your opinion of Goldman Sachs and its swarm of Wall Street allies has rock-bottomed at raw loathing. You're wrong. There's more. It turns out that the most destructive of all their recent acts has barely been discussed at all. Here's the rest. This is the story of how some of the richest people in the world – Goldman, Deutsche Bank, the traders at Merrill Lynch, and more – have caused the starvation of some of the poorest people in the world.

It starts with an apparent mystery. At the end of 2006, food prices across the world started to rise, suddenly and stratospherically. Within a year, the price of wheat had shot up by 80 per cent, maize by 90 per cent, rice by 320 per cent. In a global jolt of hunger, 200 million people – mostly children – couldn't afford to get food any more, and sank into malnutrition or starvation. There were riots in more than 30 countries, and at least one government was violently overthrown. Then, in spring 2008, prices just as mysteriously fell back to their previous level. Jean Ziegler, the UN Special Rapporteur on the Right to Food, calls it "a silent mass murder", entirely due to "man-made actions."

Earlier this year I was in Ethiopia, one of the worst-hit countries, and people there remember the food crisis as if they had been struck by a tsunami. "My children stopped growing," a woman my age called Abiba Getaneh, told me. "I felt like battery acid had been poured into my stomach as I starved. I took my two daughters out of school and got into debt. If it had gone on much longer, I think my baby would have died."

Most of the explanations we were given at the time have turned out to be false. It didn't happen because supply fell: the International Grain Council says global production of wheat actually increased during that period, for example. It isn't because demand grew either: as Professor Jayati Ghosh of the Centre for Economic Studies in New Delhi has shown, demand actually fell by 3 per cent. Other factors – like the rise of biofuels, and the spike in the oil price – made a contribution, but they aren't enough on their own to explain such a violent shift.

To understand the biggest cause, you have to plough through some concepts that will make your head ache – but not half as much as they made the poor world's stomachs ache.

For over a century, farmers in wealthy countries have been able to engage in a process where they protect themselves against risk. Farmer Giles can agree in January to sell his crop to a trader in August at a fixed price. If he has a great summer, he'll lose some cash, but if there's a lousy summer or the global price collapses, he'll do well from the deal. When this process was tightly regulated and only companies with a direct interest in the field could get involved, it worked.

Then, through the 1990s, Goldman Sachs and others lobbied hard and the regulations were abolished. Suddenly, these contracts were turned into "derivatives" that could be bought and sold among traders who had nothing to do with agriculture. A market in "food speculation" was born.

So Farmer Giles still agrees to sell his crop in advance to a trader for £10,000. But now, that contract can be sold on to speculators, who treat the contract itself as an object of potential wealth. Goldman Sachs can buy it and sell it on for £20,000 to Deutsche Bank, who sell it on for £30,000 to Merrill Lynch – and on and on until it seems to bear almost no relationship to Farmer Giles's crop at all.

If this seems mystifying, it is. John Lanchester, in his superb guide to the world of finance, Whoops! Why Everybody Owes Everyone and No One Can Pay, explains: "Finance, like other forms of human behaviour, underwent a change in the 20th century, a shift equivalent to the emergence of modernism in the arts – a break with common sense, a turn towards self-referentiality and abstraction and notions that couldn't be explained in workaday English." Poetry found its break with realism when T S Eliot wrote "The Wasteland". Finance found its Wasteland moment in the 1970s, when it began to be dominated by complex financial instruments that even the people selling them didn't fully understand.

So what has this got to do with the bread on Abiba's plate? Until deregulation, the price for food was set by the forces of supply and demand for food itself. (This was already deeply imperfect: it left a billion people hungry.) But after deregulation, it was no longer just a market in food. It became, at the same time, a market in food contracts based on theoretical future crops – and the speculators drove the price through the roof.

Here's how it happened. In 2006, financial speculators like Goldmans pulled out of the collapsing US real estate market. They reckoned food prices would stay steady or rise while the rest of the economy tanked, so they switched their funds there. Suddenly, the world's frightened investors stampeded on to this ground.

So while the supply and demand of food stayed pretty much the same, the supply and demand for derivatives based on food massively rose – which meant the all-rolled-into-one price shot up, and the starvation began. The bubble only burst in March 2008 when the situation got so bad in the US that the speculators had to slash their spending to cover their losses back home. more

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