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Simran Gill » Blog Archive » Microfinance – A zero sum game?
May
04
2007

ArticlesMicrofinance – A zero sum game?

Newsflash: Natalie Portman is simultaneously embracing myspace and microfinance. I came across the bit of news at one of my regular reads, dealbreaker.com. The best part, though, was located in the comments section:

how does one end poverty? isn’t that like getting everybody to be above average? The redistributionists will always complain that people are in the bottom decile, quintile, quartile, whatever and that we need to take from the top and give to them. Seriously, when I hear people say we need to eliminate poverty I always scratch my head as to what that means.

Posted by: joe | May 3, 2007 05:23 PM

That’s right Joe – it’s a zero sum game. That’s why when bums ask me for money I kick them in the nuts and take their change.

Posted by: BSD | May 3, 2007 05:34 PM

Am I crazy? This is the funniest thing I’ve seen all day. A beautifully sardonic response by BSD.

It’s amazing to me how many people falsely believe that trade, or investment, is a zero-sum game (and microfinance is a form of investment, not charity or merely redistribution as joe mentioned above). Let’s take a look at how value is created through trade, and subsequently through microfinance:

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Trade in Undeveloped Economies

Here we have a simple barter exchange. Johnny trades his apples for Mahir’s Chicken. Johnny chooses to make the exchange because he feels he is better off with the chicken rather than his apples – Likewise, Mahir feels better off with the apples rather than his chicken. In this example, as in all trades made under free will, all parties believe they are better off making the trade rather than not. There is no loser – they are both educated about the products they are buying, and have the expectation they will end up wealthier. The economic system has been enriched – greater wealth has been created, and Johnny didn’t need to kick Mahir in the nuts.

Trade/Lending in Developed Economies

The process is similar in developed economies. Jasbir the banker has chosen to trade his little blue piglet filled with coins for a future cashflow from Ping the small business owner (who has decided to invest in his business). In this example, as above, all parties enter the contract expected to be better off, and a net creation of wealth occurs. In this example, as above, both Ping and Jasbir need to be educated of the risks they are undertaking.

Lending in Undeveloped Economies

Unfortunately, here is where the problem starts. Mahir, like many others in undeveloped economies, lacks two critical pieces to the wealth creation puzzle:

  • Knowledge of the lending process (analogous to his knowledge of apples)
  • Access to capital (analogous to the scarcity of apples)

Unlike when Mahir traded his chicken for Johnny’s apples, Mahir now lacks the necessary knowledge to assess whether he is getting himself into a good deal. Mahir knows his chickens, but doesn’t know his future cashflows; because of this, the risks to both Enrico and Mahir are increased. Enrico the usurious lender is in an advantageous position – He has a scarce resource and an informational advantage. Mahir does not have the opportunity to shop for other lenders, due to both to collusion and limited market size. In this case, either the deal will not go through (and wealth will not be created), or somebody will get kicked in the nuts.

Microfinance in Undeveloped Economies

Here comes Olga the microlender to even the playing field for Mahir. In addition to providing Mahir with greater access to capital, she also provides the necessary education for Mahir to understand the process of borrowing and the risks associated. With this information, Mahir is in a better position to invest into his business(He buys a cart to carry more chickens to the market improving his productivity), and successfully meet his obligations. Additionally, Olga, unlike Enrico, does not rely on usurious rates, and instead aims to perpetuate the microlending process by recycling capital and lending to others like Mahir – Her goal is one of sustainment, rather than either profit or charity. In this example, just as when Mahir traded with Johnny, wealth is created – Fortunately for others, the wealth created will be spread between Mahir, and the future trading partners of Olga.

It’s important to also recognize that along with the increased risks associated with investing in undeveloped economies, there’s my favorite benefit: Due to the lack of capital and excess of available labour in these economies, the marginal productivity of capital will greatly exceed that of developed nations. Unfortunately, this is partially countered by a lack of productivity enabling infrastructure. Opening countries up to more fluid investment will benefit all, but requires political stability, intelligent investments in infrastructure, and adoption of current technology.

Solow Model – Moving developing economies from K0 to K* makes more sense than moving us from K* to K1

That’s enough of me playing with clipart today. I hope I made my point – There’s no need to be kicking anyone in the nuts.

2 Responses to “Microfinance – A zero sum game?”

  1. mr. closets says:

    Great piece! I love nothing better than a simple (yet non-condescending) explanation with color graphics.

  2. Mike Singh says:

    How are capital making resources supposed to be developed in third world countries when there are few resources to begin with. Maybe this should equate to the greater powers dividing their resources onto these regions but which economies political rulers are willing to accommodate this change?

    Refer back to Malthus’s theory on wordwide subsistence. The population continues to grow exponentially whilst the food/resource of life continues at a linear rate. In the future the disparity between the rich and poor countries should only grow with this assumption.

    Not that this is an excuse to stop trying but what is actually helping? There’s other theorists that dignify the current situation as a result of the current economies and resources we have in place as on this earth etc. It defnitely is a zero sums finance because even if these nations were to become a little more developed that would mean removing the prosperity from another economy – based on Malthus’s model?

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