Economic Development - Micro Finance and Fair Trade

Introduction

Although many of the broad approaches to economic growth and development are “top-down” in nature – for example an ambitious government strategy to increase productivity or attract foreign direct investment projects – there has been growing interest and investment in a bottom-up or grassroots approach to enterprise and innovation supported by the micro-finance industry. The world’s poor are exposed toirregular income flows, and their needs are irregular too – ranging from unforeseen medical bills to having to pay more when food prices rise unexpectedly.

Microfinance refers to a large number of different financial products, including but not exclusive to

• Micro-credit - the provision of small-scale loans to the poor for example by credit unions
• Micro-savings – for example, voluntary local savings clubs provided by charities
• Micro-insurance- especially for people and businesses not traditionally served by commercial insurance businesses - a safety net to prevent people from falling back into extreme poverty
• Remittance management – managing remittance payments sent from one country to another including for example transfer payments made through mobile phone solutions

The concept of microcredit was first introduced in Bangladesh by Professor Muhammad Yunus who started the Grameen Bank (GB) more than 30 years ago with the aim of reducing poverty by providing small loans to the country’s rural poor. At the end of 2009 in Bangladesh, there were 20.5 million active borrowers and the average loan per borrower was $114. Global funding for microfinance reached $25 billion in 2011. Microfinance institutions (MFIs) had extended loans to more than 200 million clients by the end of 2010.

A key feature of micro-finance has been the targeting of women on the grounds that compared to men, they perform better as clients of microfinance institutions and that their participation has more desirable long-term development outcomes. The Grameen Bank approach initially focused on small groups ‘lending circles’ of largely female entrepreneurs from the poorest level in the society. This became the widely accepted view of what microfinance is. In reality there are thousands of commercial microfinance institutions (MFIs) including some large international operators. Microfinance programmes also exist in advanced countries, such as Germany, the USA and also in Scotland in the United Kingdom.

• Commercial micro-credit businesses – profit seeking
• Not-for-profit micro-credit businesses – social enterprises, reinvesting profits for social purposes
• Donor-supported micro-credit businesses – perhaps targeted at supporting the very poorest – an example being the savings schemes established by CARE international

Broad aims of micro-credit

Evaluation: Criticisms of Micro-Credit

Micro-finance has come under close scrutiny in recent years and there are many who argue that the positive effects of micro-finance have been exaggerated and that the rapid expansion of micro-credit has caused unintended consequences and limited benefits in reducing extreme poverty. Some of the criticisms are as follows:

SKS Microfinance in India

In India the commercial business SKS microfinance was floated on the Indian stock exchange in 2010 but their share price has fallen by more than 90% since then. The Indian government responded to criticisms of alleged harassment of borrowers by SKS agents by introducing stricter controls on micro-credit. Several reported suicides of people in multiple and heavy debt to lenders had a damaging effect on the reputation of SKS. It made a loss of 13.61bn rupees for the year ending March 2012, compared with a profit of 1.12bn rupees in the previous year.

Micro-Insurance

This is a growing sector within developing country finance. The number of people covered by micro-insurance has increased almost 6.5 fold in five years, reaching nearly 500 million worldwide, with China and India leading the charge

Micro-insurance attempts to protect poor people against risks arising from accidents, illness, and a death in the family or the damage caused by natural disasters - in exchange for insurance premium payments tailored to their needs, income and level of risk.

Examples of micro-insurance include:

• An Indian fertiliser company providing free insurance with each bag of fertiliser bought
• Cattle insurance policies – small scale insurance policies that cover the death of animals due to accident, disease, foods, drought and other events
• Life insurance and accident cover bundled with farmers or other business people buying new trucks
• Pay-as-you-plant insurance for Kenyan farmers to insure inputs against drought and excess rain
• In South Africa, HIV patients can get life insurance providing they sign up to regular medical check-ups and adherence to taking courses of freely available antiretroviral treatments

Micro-insurance schemes can dove-tail with mobile money transfer systems such as M-PESA – for example farmers can have their insurance pay-outs sent directly through to them without having to trek into the nearest town or city.

Benefits from effective and affordable micro-insurance projects

Risks and limitations of micro-insurance

Naturally there are problems with building insurance schemes for many of the world’s poorest communities – some are standard economic arguments:

• Moral hazard – insured people and businesses may take less steps to protect themselves against risks because they know they have the safety net of insurance
• Adverse selection – the highest risk agents will tend to be those who bid for insurance products increasing the pooled risks of insurance everyone
• Asymmetric information – often times, those seeking insurance have more information about their conditions than agents selling the insurance
• Inertia and information gaps – until recently, the vast majority of people in developing countries had no access at all to formal insurance schemes, and those that were available could not be afforded save for the wealthy few. Many need to be educated about the basics of insurance and the costs and benefits of getting involved.

A good case study of the expansion of micro-insurance is the success of the financial inclusion fund set up by Leapfrog backed by JP Morgan and the George Soros Foundation.

Fair Trade

• The Fair Trade movement now covers over 650 producer organisations in more than 60 countries
• One of the driving forces behind the founders of Fair Trade was a desire to correct for multiple market failures in industries for many primary sector commodities. These failures included the effects of monopsony power among transnational food processors and food manufacturers which often led to farmers in some of the world's poorest countries receiving an inequitably low and unsustainable price for their products.

The Fair Trade Foundation web site explains fair trade as follows:

"Fairtrade is about better prices, decent working conditions, local sustainability, and fair terms of trade for farmers and workers in the developing world. By requiring companies to pay sustainable prices (which must never fall lower than the market price), Fairtrade addresses the injustices of conventional trade, which traditionally discriminates against the poorest, weakest producers. It enables them to improve their position and have more control over their lives."

The key aims of Fair Trade are to:

• Guarantee a higher / premium price to certified producers
• Achieve greater price stability for growers
• Improve production standards. A grower will be able to receive a Fair Trade licence if it can improveworking conditions, better pay and guarantees of environmental sustainability
• A Fairtrade premium price might be offered - for direct investment in improving businesses and communities. For example in 2008 Tate & Lyle announced all their retail sugar would be Fairtrade, benefiting 6000 sugar producers in Belize who will receive a Fairtrade premium

The Fair Trade movement has critics

• Impact on non-participating farmers: Some claim that by encouraging consumers to buy their products from Fairtrade sources, this cuts demand for farmers in poorer nations not covered by the Fairtrade label thereby worsening the risk of extreme poverty
• Who captures the gains from Fair-Trade coffee? There is some evidence that a large part of the premium price goes to processors and distributors rather than the farmers themselves.
• Others argue that the fundamental causes of poverty are not really addressed by Fairtrade. Greater investment needs to be made in raising farm productivity, reducing vulnerability to climate change, and reaching multi-lateral trade agreements between countries to reduce import tariffs andimprove access for poor countries into the markets of rich advanced nations. Other investment might be better targeted at encouraging farmers to establish producer co-operatives of their own and create their own branded products selling direct to consumers.
• Some free market think-tanks such as the Adam Smith Institute believe that the fair trade movement has resulted for example in excess production of coffee, which has driven down world coffee prices.

Tourism and Economic Development

For many developing countries tourism is already a major part of their economy and a significant source of income and employment. But there is a fierce debate about the consequences of tourism - what role can tourism play in economic development? Can travel to developing countries do more harm than good?

Tourism as a threat to sustainable growth and development

Background on the global tourism industry:

• Globally, tourism is a $3 billion a day industry
• The income elasticity of demand for overseas travel and tourism is high
• According to a recent United Nations Report, in over 150 countries, tourism is one of five top export earners, and in 60 it is the number one export
• Developing countries account for 40% of world tourism arrivals and 30% of tourism receipts
• South-South tourism is growing rapidly – i.e. from developing to other developing countries
• Women make up 70 per cent of the labour force in the tourism sector, and half of all tourism workers are 25 or under