Financing Businesses in Africa: The Role of Microfinance

The law of diminishing marginal productivity dictates that scarce resources earn a high return. Why then, does capital not flow to the poor, its most productive users? This has been attributed in part to the failure of credit markets. The argument goes that the poor have so little to offer by way of collateral, and borrow such small amounts, that it is too risky and expensive to lend to them. The ramification is that they get caught in a credit-based poverty trap, wherein they are unable to undertake profitable investments due to credit constraints and hence, remain poor. The great promise of microcredit — making joint-liability loans to small groups of poor people possessing no collateral, enabling them to make productive investments — was to be the magic bullet against poverty. Yet, a mere five years after the Nobel Peace Prize was awarded to Muhammad Yunus and the Grameen Bank, claims about microcredit’s transformative power are being debated.