However, anyone who is from or has lived for a period in a developing country will know that it is teeming with entrepreneurs. On the streets of poor countries, you will meet men, women and children of all ages selling everything you can think of, and things that you did not even know could be bought. In many poor countries, you can buy a place in the queue for the visa section of the American embassy (sold to you by professional queuers), the service to ‘watch your car’ (meaning ‘refrain from damaging your car’) in street-parking slots, the right to set up a food stall on a particular corner (perhaps sold by the corrupt local police boss) or even a patch of land to beg from (sold to you by the local thugs). These are all products of human ingenuity and entrepreneurship.
In contrast, most citizens of rich countries have not even come near to becoming entrepreneurs. They mostly work for a company, some of them employing tens of thousands, doing highly specialized and narrowly specified jobs. Even though some of them dream of, or at least idly talk about, setting up their own businesses and ‘becoming my own boss’, few put it into practice because it is a difficult and risky thing to do. As a result, most people from rich countries spend their working lives implementing someone else’s entrepreneurial vision, and not their own.
The upshot is that people are far more entrepreneurial in the developing countries than in the developed countries. According to an OECD study, in most developing countries 30–50 per cent of the non-agricultural workforce is self-employed (the ratio tends to be even higher in agriculture). In some of the poorest countries the ratio of people working as one-person entrepreneurs can be way above that: 66.9 per cent in Ghana, 75.4 per cent in Bangladesh and a staggering 88.7 per cent in Benin.1 In contrast, only 12.8 per cent of the non-agricultural workforce in developed countries is self-employed. In some countries the ratio does not even reach one in ten: 6.7 per cent in Norway, 7.5 per cent in the US and 8.6 per cent in France (it turns out that Mr Bush’s complaint about the French was a classic case of the pot calling the kettle black). So, even excluding the farmers (which would make the ratio even higher), the chance of an average developing-country person being an entrepreneur is more than twice that for a developed-country person (30 per cent vs. 12.8 per cent). The difference is ten times, if we compare Bangladesh with the US (7.5 per cent vs. 75.4 per cent). And in the most extreme case, the chance of someone from Benin being an entrepreneur is a whopping thirteen times higher than the equivalent chance for a Norwegian (88.7 per cent vs. 6.7 per cent).
Moreover, even those people who are running businesses in the rich countries need not be as entrepreneurial as their counterparts in the poor countries. For developing-country entrepreneurs, things go wrong all the time. There are power cuts that screw up the production schedule. Customs won’t clear the spare parts needed to fix a machine, which has been delayed anyway due to problems with the permit to buy US dollars. Inputs are not delivered at the right time, as the delivery truck broke down – yet again – due to potholes on the road. And the petty local officials are bending, and even inventing, rules all the time in order to extract bribes. Coping with all these obstacles requires agile thinking and the ability to improvise. An average American businessman would not last a week in the face of these problems, if he were made to manage a small company in Maputo or Phnom Penh.
So we are faced with an apparent puzzle. Compared to the rich countries, we have far more people in developing countries (in proportional terms) engaged in entrepreneurial activities. On top of that, their entrepreneurial skills are much more frequently and severely tested than those of their counterparts in the rich countries. Then how is it that these more entrepreneurial countries are the poorer ones?
Great expectations – microfinance enters the scene
The seemingly boundless entrepreneurial energy of poor people in poor countries has, of course, not gone unnoticed. There is an increasingly influential view that the engine of development for poor countries should be the so-called ‘informal sector’, made up of small businesses that are not registered with the government.
The entrepreneurs in the informal sector, it is argued, are struggling not because they lack the necessary vision and skills but because they cannot get the money to realize their visions. The regular banks discriminate against them, while the local money-lenders charge prohibitive rates of interest. If they are given a small amount of credit (known as a ‘microcredit’) at a reasonable interest rate to set up a food stall, buy a mobile phone to rent out, or get some chickens to sell their eggs, they will be able to pull themselves out of poverty. With these small enterprises making up the bulk of the developing country’s economy, their successes would translate into overall economic development.
The invention of microcredit is commonly attributed to Muhammad Yunus, the economics professor who has been the public face of the microcredit industry since he set up the pioneering Grameen Bank in his native Bangladesh in 1983, although there were similar attempts before. Despite lending to poor people, especially poor women, who were traditionally considered to be high-risk cases, the Grameen Bank boasted a very high repayment ratio (95 per cent or more), showing that the poor are highly bankable. By the early 1990s, the success of the Grameen Bank, and of some similar banks in countries such as Bolivia, was noticed, and the idea of microcredit – or more broadly microfinance, which includes savings and insurance, and not just credit – spread fast.
The recipe sounds perfect. Microcredit allows the poor to get out of poverty through their own efforts, by providing them with the financial means to realize their entrepreneurial potential. In the process, they gain independence and self-respect, as they are no longer relying on handouts from the government and foreign aid agencies for their survival. Poor women are particularly empowered by microcredit, as it gives them the ability to earn an income and thus improve their bargaining positions vis-à-vis their male partners. Not having to subsidize the poor, the government feels less pressure on its budget. The wealth created in the process, naturally, makes the overall economy, and not just the informal sector entrepreneurs, richer. Given all this, it is not a surprise that Professor Yunus believes that, with the help of microfinance, we can create ‘a poverty-free world [where the] only place you can see poverty is in the museum’.
By the mid 2000s, the popularity of microfinance reached fever pitch. The year 2005 was designated the International Year of Microcredit by the United Nations, with endorsements from royalty, like Queen Rania of Jordan, and celebrities, like the actresses Natalie Portman and Aishwarya Rai. The ascendancy of microfinance reached its peak in 2006, when the Nobel Peace Prize was awarded jointly to Professor Yunus and his Grameen Bank.
The grand illusion
Unfortunately, the hype about microfinance is, well, just that – hype. There are growing criticisms of microfinance, even by some of its early ‘priests’. For example, in a recent paper with David Roodman, Jonathan Morduch, a long-time advocate of microfinance, confesses that ‘[s]trikingly, 30 years into the microfinance movement we have little solid evidence that it improves the lives of clients in measurable ways’.2 The problems are too numerous even to list here; anyone who is interested can read the fascinating recent book by Milford Bateman, Why Doesn’t Microfinance Work? 3 But those most relevant to our discussion are as follows.
The microfinance industry has always boasted that its operations remain profitable without government subsidies or contributions from international donors, except perhaps in the initial teething phase. Some have used this as evidence that the poor are as good at playing the market as anyone else, if you will just let them. However, it turns out that, without subsidies from governments or international donors, microfinance institutions have to charge, and have been charging, near-usurious rates. It has been revealed that the Grameen Bank could initially charge reasonable interest rates only because of the (hushed-up) subsidies it was getting from the Bangladeshi government and international donors. If they are not subsidized, microfinance institutions hav
e to charge interest rates of typically 40–50 per cent for their loans, with rates as high as 80–100 per cent in countries such as Mexico. When, in the late 1990s, it came under pressure to give up the subsidies, the Grameen Bank had to relaunch itself (in 2001) and start charging interest rates of 40–50 per cent.
With interest rates running up to 100 per cent, few businesses can make the necessary profits to repay the loans, so most of the loans made by microfinance institutions (in some cases as high as 90 per cent) have been used for the purpose of ‘consumption smoothing’ – people taking out loans to pay for their daughter’s wedding or to make up for a temporary fall in income due to the illness of a working family member. In other words, the vast bulk of microcredit is not used to fuel entrepreneurship by the poor, the alleged goal of the exercise, but to finance consumption.
More importantly, even the small portion of microcredit that goes into business activities is not pulling people out of poverty. At first, this sounds inexplicable. Those poor people who take out microcredit know what they are doing. Unlike their counterparts in rich countries, most of them have run businesses of one kind or another. Their business wits are sharpened to the limit by their desperation to survive and sheer desire to get out of poverty. They have to generate very high profits because they have to pay the market rate of interest. So what is going wrong? Why are all these people – highly motivated, in possession of relevant skills and strongly pressured by the market – making huge efforts with their business ventures, producing such meagre results?
When a microfinance institution first starts its operation in a locality, the first posse of its clients may see their income rising – sometimes quite dramatically. For example, when in 1997 the Grameen Bank teamed up with Telenor, the Norwegian phone company, and gave out microloans to women to buy a mobile phone and rent it out to their villagers, these ‘telephone ladies’ made handsome profits – $750–$1,200 in a country whose annual average per capita income was around $300. However, over time, the businesses financed by microcredit become crowded and their earnings fall. To go back to the Grameen phone case, by 2005 there were so many telephone ladies that their income was estimated to be around only $70 per year, even though the national average income had gone up to over $450. This problem is known as the ‘fallacy of composition’ – the fact that some people can succeed with a particular business does not mean that everyone can succeed with it.
Of course, this problem would not exist if new business lines could be constantly developed – if one line of activity becomes unprofitable due to overcrowding, you simply open up another. So, for example, if phone renting becomes less profitable, you could maintain your level of income by manufacturing mobile phones or writing the software for mobile phone games. You will obviously have noticed the absurdity of these suggestions – the telephone ladies of Bangladesh simply do not have the wherewithal to move into phone manufacturing or software design. The problem is that there is only a limited range of (simple) businesses that the poor in developing countries can take on, given their limited skills, the narrow range of technologies available, and the limited amount of finance that they can mobilize through microfinance. So, you, a Croatian farmer who bought one more milk cow with a microcredit, stick to selling milk even as you watch the bottom falling out of your local milk market thanks to the 300 other farmers like you selling more milk, because turning yourself into an exporter of butter to Germany or cheese to Britain simply isn’t possible with the technologies, the organizational skills and the capital you have.
No more heroes any more
Our discussion so far shows that what makes the poor countries poor is not the lack of raw individual entrepreneurial energy, which they in fact have in abundance. The point is that what really makes the rich countries rich is their ability to channel the individual entrepreneurial energy into collective entrepreneurship.
Very much influenced by capitalist folklore, with characters such as Thomas Edison and Bill Gates, and by the pioneering work of Joseph Schumpeter, the Austrian-born Harvard economics professor, our view of entrepreneurship is too much tinged by the individualistic perspective – entrepreneurship is what those heroic individuals with exceptional vision and determination do. By extension, we believe that any individual, if they try hard enough, can become successful in business. However, if it ever was true, this individualistic view of entrepreneurship is becoming increasingly obsolete. In the course of capitalist development, entrepreneurship has become an increasingly collective endeavour.
To begin with, even exceptional individuals like Edison and Gates have become what they have only because they were supported by a whole host of collective institutions (see Thing 3): the whole scientific infrastructure that enabled them to acquire their knowledge and also experiment with it; the company law and other commercial laws that made it possible for them subsequently to build companies with large and complex organizations; the educational system that supplied highly trained scientists, engineers, managers and workers that manned those companies; the financial system that enabled them to raise a huge amount of capital when they wanted to expand; the patent and copyright laws that protected their inventions; the easily accessible market for their products; and so on.
Furthermore, in the rich countries, enterprises cooperate with each other a lot more than do their counterparts in poor countries, even if they operate in similar industries. For example, the dairy sectors in countries such as Denmark, the Netherlands and Germany have become what they are today only because their farmers organized themselves, with state help, into cooperatives and jointly invested in processing facilities (e.g., creaming machines) and overseas marketing. In contrast, the dairy sectors in the Balkan countries have failed to develop despite quite a large amount of microcredit channelled into them, because all their dairy farmers tried to make it on their own. For another example, many small firms in Italy and Germany jointly invest in R&D and export marketing, which are beyond their individual means, through industry associations (helped by government subsidies), whereas typical developing country firms do not invest in these areas because they do not have such a collective mechanism.
Even at the firm level, entrepreneurship has become highly collective in the rich countries. Today, few companies are managed by charismatic visionaries like Edison and Gates, but by professional managers. Writing in the mid twentieth century, Schumpeter was already aware of this trend, although he was none too happy about it. He observed that the increasing scale of modern technologies was making it increasingly impossible for a large company to be established and run by a visionary individual entrepreneur. Schumpeter predicted that the displacement of heroic entrepreneurs with what he called ‘executive types’ would sap the dynamism from capitalism and eventually lead to its demise (see Thing 2).
Schumpeter has been proven wrong in this regard. Over the last century, the heroic entrepreneur has increasingly become a rarity and the process of innovation in products, processes and marketing – the key elements of Schumpeter’s entrepreneurship – has become increasingly ‘collectivist’ in its nature. Yet, despite this, the world economy has grown much faster since the Second World War, compared to the period before it. In the case of Japan, the firms have even developed institutional mechanisms to exploit the creativity of even the lowliest production-line workers. Many attribute the success of the Japanese firms, at least partly, to this characteristic (see Thing 5).
If effective entrepreneurship ever was a purely individual thing, it has stopped being so at least for the last century. The collective ability to build and manage effective organizations and institutions is now far more important than the drives or even the talents of a nation’s individual members in determining its prosperity (see Thing 17). Unless we reject the myth of heroic individual entrepreneurs and help them build institutions and organizations of collective entrepreneurship, we will never see the poor countries grow out of poverty on a sustainable basis.
Thing 16
&n
bsp; We are not smart enough to
leave things to the market
What they tell you
We should leave markets alone, because, essentially, market participants know what they are doing – that is, they are rational. Since individuals (and firms as collections of individuals who share the same interests) have their own best interests in mind and since they know their own circumstances best, attempts by outsiders, especially the government, to restrict the freedom of their actions can only produce inferior results. It is presumptuous of any government to prevent market agents from doing things they find profitable or to force them to do things they do not want to do, when it possesses inferior information.
What they don’t tell you
People do not necessarily know what they are doing, because our ability to comprehend even matters that concern us directly is limited – or, in the jargon, we have ‘bounded rationality’. The world is very complex and our ability to deal with it is severely limited. Therefore, we need to, and usually do, deliberately restrict our freedom of choice in order to reduce the complexity of problems we have to face. Often, government regulation works, especially in complex areas like the modern financial market, not because the government has superior knowledge but because it restricts choices and thus the complexity of the problems at hand, thereby reducing the possibility that things may go wrong.
Markets may fail, but . . .
As expressed by Adam Smith in the idea of the invisible hand, free-market economists argue that the beauty of the free market is that the decisions of isolated individuals (and firms) get reconciled without anybody consciously trying to do so. What makes this possible is that economic actors are rational, in the sense that they know best their own situations and the ways to improve them. It is possible, it is admitted, that certain individuals are irrational or even that a generally rational individual behaves irrationally on occasion. However, in the long run, the market will weed out irrational behaviours by punishing them – for example, investors who ‘irrationally’ invest in over-priced assets will reap low returns, which forces them either to adjust their behaviour or be wiped out. Given this, free-market economists argue, leaving it up to the individuals to decide what to do is the best way to manage the market economy.
23 Things They Don't Tell You about Capitalism Page 17
