Dead Aid: Why Aid Is Not Working and How There Is a Better Way for Africa

by Moyo, Dambisa

  African countries must also focus on their non-tradeable sector by encouraging their entrepreneurs (of course, FDI can boost the non-tradeable sector also). The entrepreneurs (their small and medium-sized enterprises) are the life-blood of any economy, and the crucial emerging private sector in poor countries is the engine for private-sector-led growth. Yet, although small and medium enterprises (SMEs) are a significant part of the total employment in the most developed and rapidly developing countries, their share across African economies (rather disturbingly given the abundance of labour) lags behind. Whereas SMEs (defined as formal-sector enterprises with up to 250 employees) account for as much as 60 per cent across countries like Japan, Denmark and Ireland (and more than 80 per cent in Italy and Greece), Zambia’s share of SMEs is 40 per cent, and Cameroon’s just 20 per cent. If these two African countries are anything to go by there is clearly much scope for improvement across the board.

  Entrepreneurs need a receptive and user-friendly environment within which to thrive, but they also need money. Entrepreneurial firms are more likely to spring up in countries where there is better access to finance (as well as business environments where it’s easier to do business). Fortunately, there are other non-aid ways to finance themselves and contribute to their countries’ development.

  9. Banking on the Unbankable

  In December 2006, Muhammad Yunus, a Bangladeshi national, was awarded the Nobel Peace Prize.1 His work on structuring financing in Bangladesh revolutionized the thinking on how to lend to the poorest, and most rural, segments of countries; that is, the communities in which the majority of poor people are employed in the agricultural sector, often buffeted by unpredictable events, and live in villages which lack physical infrastructure (roads or power supplies), making the costs of establishing a formal banking network prohibitive.

  Professor Yunus’s innovation was to find a way to lend to the poorest of the poor who have no collateral – no house, no car, no tangible asset against which to borrow. People whose only nominal personal wealth would probably be in the form of land, where the collateral is undocumented and legally unenforceable.

  Looking across Bangladesh, Yunus realized that although many villages had no obvious visible asset, they all shared one thing – a community of interdependence and trust. The genius behind Yunus’s Grameen Bank (literally translated from Bengali as ‘Bank of the Village’) was in converting that trust into collateral.2

  The mechanics of Grameen Bank’s solidarity lending are pretty straightforward. Take a small village with five traders for a basic illustration. Through its micro-lending programme, the Grameen Bank lends the group US$100. Within the group the US$100 is passed on to trader A for a pre-specified period (a loan period currently runs for about one year). At the end of this time, she (97 per cent of Grameen’s loans are made to women) has to pay back to Grameen Bank the loan amount plus interest (which can be between 8 and 12 per cent). Trader A is solely responsible for repaying her loan. When the loan is repaid, the next US$100 loan is made to the group, which is then passed on to trader B. But if trader A does not repay, the group is extended no further loans.

  Although, technically speaking, there is no group joint liability (the group as a whole is not responsible for the loan when one member defaults), the group is implicitly liable in the sense that the behaviour of each individual member affects the group as a whole. So very often when difficulties in repayment do arise, the group members contribute the defaulted amount (with an intention of collecting the money from the defaulted member at a later time), thus keeping the loan-cycle turning. In this sense microfinance in poor countries works much like credit cards in rich countries – borrowers repay their loans because they know that if they don’t pay the loans they have today, their lender will blacklist them, and they won’t be able to borrow more tomorrow. The bonds of trust extend not only between the members of the group, but also between the group and the bank – there is no legal instrument between Grameen Bank and its borrowers.

  The Grameen model has met with resounding success. At least forty-three countries around the world have adopted some version of it. Grameen Bank initially offered micro-finance to 36,000 members with a portfolio of US$3.1 million when it became a bank in 1983. By 1997, it had 2.3 million members and a portfolio of US$230 million. Perhaps most impressively, its default rates are at less than 2 per cent and, with its success, the bank now provides a host of other financial services (beyond also insurance and pension schemes) to the poor – micro-enterprise, scholarships and housing programmes.

  According to Grameen Bank estimates from March 2008, over 1.3 million members took micro-enterprise loans (mainly for power-tillers, irrigation pumps, motor vehicles, and river craft for transportation and fishing), for a total of over US$450 million. On the education side, scholarships amounting to US$950,000 have been awarded to over 50,000 children, and by March 2008 nearly 23,000 students received higher-education loans, many for medicine, engineering and professional certificates. Finally, in the twelve months to February 2008, Grameen housing loans alone have reached US$1.19 million with some 8,300 houses having been built. Since the housing programme’s inception in 1984, over 650,000 houses have been constructed.

  The most truly extraordinary aspect of this extraordinary tale is their ‘No Donor Money, No Loans’ policy. In 1995, Grameen Bank decided not to receive any more donor funds, and today funds itself 100 per cent through its deposits. Although recognized as the grandfather of micro-credit and micro-lending, Grameen Bank has spawned numerous variations all over the world, all targeting the segment of the population that has fallen through the high-street banking cracks. The BKI in Indonesia, Acción in Latin America, BRAC in Bangladesh and K-REP in Kenya are just a sample of the growing and expansive list.

  In Africa, Zambia offers an interesting case study of how microfinance has developed. Traditionally, conservative banking institutions have generally targeted large and established companies (for example, those in the mining sector) and shown little appetite for small businesses and individuals (save a few high-income salaried earners). In a population of around 10 million people, where only about 500,000 are formally employed, some 9.5 million (although this includes children) remained ignored by the banking sector. Enter micro-finance. The many thousands of would-be Zambian entrepreneurs finally had a way to secure capital to fund their businesses.

  In practice, like many other poor countries, the Zambian micro-finance market can be split into three tiers. The first two target salaried workers, who pay different rates of interest depending on their employer. In the first tier are civil servants (doctors, teachers and military personnel), who by virtue of working for the government are charged relatively low interest rates. Second come salaried professionals, not employed by government (lawyers and bankers) and who, because they work in the private sector and do not have the security of the government behind them, are charged a higher rate of interest. In each of these two cases, the micro-loan lender uses the salary as collateral – using the individuals’ wage to directly secure the loan.

  The third category, which encompasses the vast majority of Zambia’s poor, and for which the Grameen Bank structure was originally intended, are the unsalaried, often rural poor, with variable incomes, and generally no access to loan capital – think of a woman selling tomatoes on a side street. Yet this group – the real entrepreneurs, the backbone of Zambia’s economic future – need capital just as much as the mining company to see their businesses established and grow.

  In Zambia, as in other African countries where micro-finance has started to blossom, the risk of lending to the most risky is often reduced through joint liability – the notion that members of a group of borrowers are all liable for any loans that a micro-finance lender makes to them.

  Consider again a group of borrowers in a small rural village, where the lender has virtually no information on the individual borrowers. Joint liability gets around this information asymmetry in a number of ways. Wh
en forming their groups, borrowers have an incentive at the onset to match themselves with other good borrowers, and exclude those known to be high-risk. Naturally, this self-selection mechanism helps the lender screen the borrowers and reduce the risk of default. Joint liability also addresses the moral hazard lenders typically face – that is, the risk that once a loan is made, once the borrower has secured the cash, she defaults. Under joint liability, other members of the group have a vested interest to ensure their partners do not cheat, to see the loan repaid, so that they too can access funds.

  Having seen the explosion and success in micro-finance (micro-finance default rates in Zambia are less than 5 per cent), traditional banks have woken up to the opportunity that hitherto they have left untapped. Since 2000, there has been a rapid growth in international investment in micro-lending by various agencies and funds that tend to be more commercially oriented. By mid-2004, this group had invested a total of nearly US$23 billion in about 450 micro-finance institutions.

  But micro-finance is not without its naysayers. This type of lending to the poor is criticized as loan-sharking (charging punitive and exorbitant rates), as fuelling Ponzi schemes (borrowing from one lender to pay off another) and as simply supporting reckless consumption. However, with ever-increasing numbers of micro-lenders, and growing participation in this type of lending, the interest rates charged inevitably become lower and, in this sense, more competitive. As to the Ponzi scheme criticism, the objection merely points to the need for more information concerning borrowers – who’s good and who’s bad (which, by the way, is exactly the information asymmetry that the Grameen model mitigates). And on the issue of consumption versus investment, this applies to any loan, any time, anywhere.

  The important point, not to be overlooked, is that the previously unbankable and excluded poor are now part of a functioning financial dynamic. With this comes a culture of borrowing and repayment crucial for financial development in a well-oiled successful economy. Small-scale banking to poor people has the capacity to create enterprise and growth in developing countries.

  Lending to the poor is also no longer constrained by national boundaries, or by financial institutions. With the advent of Kiva, a California-based interface, pretty much anyone sitting anywhere with a keyboard can lend money to anyone across the planet.3 This is how it works: a woman in Cameroon goes on line seeking a US$200 loan towards her tailoring business. She makes her case, as best she can, and a man in Des Moines, Iowa, lends her US$25 of it, someone in Sweden lends another US$25, and the balance is covered by someone in Japan. The loan is made for a set period, for a pre-agreed interest rate, and she regularly updates her lenders on her progress. In the week – just one week – leading into 19 April 2008, over US$625,000 was lent by almost 3,000 new lenders.

  Like the Grameen model (and unlike aid) the default rates have been minimal. Thus far, since Kiva’s inception in 2005, some US$30 million has been lent, 45,000 loans made to people in forty-two countries. A wonderful innovation – get involved.

  Remember the mosquito net manufacturer who, thanks to aid, is now out of business? And remember the 176 people (one owner, ten workers and their 165 dependants) now with no stable income, dependent on handouts?

  How much better would it have been if just half of the million-dollar donation had been invested as micro-lending in the country instead? Within five years, our mosquito net manufacturer could have expanded production to meet growing demand, doubled his workforce (and by default provided support for another 150 of their dependants), and his product would be there to replace the nets as they fell into disrepair.

  Of course, other entrepreneurs, seeing how his business has flourished and recognizing the ever-present demand for mosquito nets, would venture into the market, thereby lowering the cost of the nets over time, and of course improving quality.

  What should Dongo do?

  The extension of financial services to people who otherwise have no access to banks dates as far back as when municipal savings banks began in Europe in the eighteenth century, and when German groups based on the self-help principle and called savings and credit cooperatives were first organized by Herman Schulze-Delitzsch and Friedrich Raiffeisen in the middle of the nineteenth century.

  In more recent times, micro-credit organizations were developed in the 1960s to serve Africa and Asia’s needs for agricultural support, yet most Africans today still have very limited access to financial markets. In Ghana and Tanzania, for example, only about 5–6 per cent of the population has access to the banking sector, although some 80 per cent of households in Tanzania would be prepared to save if they had access to appropriate products and saving mechanisms.

  The oldest private, worldwide, fully commercial micro-finance investment fund is the Dexia Micro-Credit Fund. It is managed by Blue Orchard Finance, a micro-finance investment consultancy, and finances some fifty micro-finance institutions in twenty-four countries. It has investments of US$77 million. However, it was really not until Grameen Bank’s success that micro-finance really took off.

  Today, micro-finance brings groups of people into the economy for the first time, by offering the poor a range of saving tools. Beyond the direct capital injection it puts into a borrower’s pockets, it can also be a powerful development tool. Even small loans can boost business productivity gains and contribute to job creation and raise family living standards (better nutrition, better health and housing, more education).

  By some estimates some 10,000 organizations (from nongovernmental organizations to registered banks) today offer over US$1 billion worth of micro-finance loans annually to many millions of customers around the world; projections are that this amount will have to grow twenty-fold (to US$20 billion) over the next five years to meet projected demand. But in more extreme forecasts, some predict even more exponential growth. Vijay Mahajan, a micro-finance practitioner, puts potential annual micro-credit demand in India alone at US$30 billion, 10 per cent of the estimated global US$300 billion.4 According to an April 2006 survey by McKinsey Consulting, India has the potential to become a US$500 billion market by the year 2020.

  Growth in most emerging-market regions has been meteoric: For example, the Bangladeshi organization BRAC signed up 5,000 customers in Afghanistan, just six months after setting up there; two Cambodian organizations (Acleda and EMT) each have over 80,000 customers; Banco do Nordeste in Brazil has become the second-largest micro-finance operation in Latin America, with 110,000 clients in just a few years; and Compartamos, in Mexico, has nearly doubled the number of its clients in the past year to become the largest Latin American programme, with over 150,000 clients.

  Despite all this expansion, the industry has yet to reach 5 per cent of the customers among the world poor. Even according to the Grameen Foundation USA’s more optimistic estimates that 10 per cent of a potential US$300 billion micro-finance market has been penetrated, there is plenty of scope for development financing through micro-lending. It’s about time Dongo, and the rest of Africa, got involved.

  Remittances

  The UN estimates that there are around 33 million Africans living outside their country of origin. Nigerians and Ghanaians principally move to the United States, Malians and Senegalese settle in France, and the majority of Congolese make their home in the Netherlands. Some 30 per cent of Mali’s population lives elsewhere. In total, emigrants represent almost 5 per cent of Africa’s total population, and they are yet another source of money to help fuel Africa’s development.

  Remittances – the money Africans abroad sent home to their families – totalled around US$20 billion in 2006 (remittances were US$68 billion and US$113 billion in Latin America and Asia, respectively). According to a United Nations report entitled Resource Flows to Africa: An Update on Statistical Trends, between 2000 and 2003 Africans sent home about US$17 billion each year, a figure that even tops FDI, which averaged US$15 billion, during this period. What is more, according to the World Bank, the figures on Africa’s remittances are m
ost likely grossly under-valued, as a lot of money makes its way to the continent through unrecorded channels (Freund and Spatafora estimate informal remittances are 35–75 per cent of the official flows); so much so that remittances may possibly be the largest source of external funding in many poor countries. At US$5 billion, Nigeria receives the greatest amount of remittances in Africa, followed by South Africa (US$1.5 billion) and Angola (US$1 billion). They accounted for roughly 40 per cent of Somalia’s 2006 GDP, the same year that six out of fifty-three countries received remittances in excess of US$1 billion. Quite clearly remittances are (and increasingly should be) a significant piece of many African countries’ financing puzzle.

  In July 2006, the UK’s Department of International Development published a report, The Black and Minority Ethnic Remittance Survey, which revealed that within black communities 34 per cent of Africans send money home to relatives. Perhaps more startling was the fact that of the almost 10,000 minority households interviewed across the UK, Black Africans were found to remit money (an average of around £910 annually, or almost US$1,800; the global average per capita is around US$200 per month) more frequently than any other group.

  Like the other forms of private capital flows already discussed, the benefits of remittances are far-reaching.

  Although the actual remittance sums taken individually are relatively small, taken collectively the remittance amounts flowing into African nations’ coffers (banks, building societies, etc.) are enormous. The US$565 million that flowed into Mozambique and the US$642 million that went to Uganda in 2006 most certainly contributed to bolstering their economies.

  Remittances can play an important part in financing a country’s external balances, by helping to pay for imports and repay external debt. As remittances tend to be more stable than other capital flows, in some countries banks have used them to securitize loans from the international capital markets – that is, to raise overseas financing using future remittances as collateral, thereby lowering borrowing costs. Banco do Brasil raised US$250 million in 2002 by using future dollar- or yen-denominated worker remittances as collateral.