James Surowiecki criticizes nanocorps, in “What Microloans Miss”:
This vogue has translated into a flood of real dollars: institutional and individual investments in microfinance more than doubled between 2004 and 2006, to $4.4 billion, and the total volume of loans made has risen to $25 billion, according to Deutsche Bank. Unfortunately, it has also translated into a flood of hype. There’s no doubt that microfinance does a tremendous amount of good, yet there are also real limits to what it can accomplish. Microloans make poor borrowers better off. But, on their own, they often don’t do much to make poor countries richer.
This isn’t because microloans don’t work; it’s because of how they work. The idealized view of microfinance is that budding entrepreneurs use the loans to start and grow businesses—expanding operations, boosting inventory, and so on. The reality is more complicated. Microloans are often used to “smooth consumption” —tiding a borrower over in times of crisis. They’re also, as Karol Boudreaux and Tyler Cowen point out in a recent paper, often used for non-business expenses, such as a child’s education. It’ s less common to find them used to fund major business expansions or to hire new employees. In part, this is because the loans can be very small—frequently as little as fifty or a hundred dollars—and generally come with very high interest rates, often above thirty or forty per cent. But it’s also because most microbusinesses aren’t looking to take on more workers. The vast majority have only one paid employee: the owner. As the economist Jonathan Morduch has put it, microfinance “rarely generates new jobs for others.”
This matters, because businesses that can generate jobs for others are the best hope of any country trying to put a serious dent in its poverty rate. Sustained economic growth requires companies that can make big investments—building a factory, say—and that can exploit the economies of scale that make workers more productive and, ultimately, richer. Microfinance evangelists sometimes make it sound as if, in an ideal world, everyone would own his own business. “All people are entrepreneurs,” Muhammad Yunus has said. But in any successful economy most people aren’t entrepreneurs—they make a living by working for someone else. Just fourteen per cent of Americans, for instance, are running (or trying to run) their own business. That percentage is much higher in developing countries—in Peru, it’s almost forty per cent. That’ s not because Peruvians are more entrepreneurial. It’s because they don’t have other options.
Surowiecki’s argument seems to have two parts: first, that the only way to create jobs is to hire people, and second, that small investments have a lower internal rate of return than larger investments --- that is, they are more efficient uses of capital.
I think neither of these arguments is correct.
As Coase pointed out decades ago, there isn’t a large distinction between a service supplier and an employee; in either case, you pay money and receive services. If there are two people engaged in making nails and five more engaged in carpentry using those nails, then if five more people take up the trade of carpentry, there is work available for two more nail-makers. It doesn’t matter whether these seven people work for the same firm, or whether they buy the nails on the open market; the number of jobs created is just the same. Similarly, economies of scale do not necessarily depend on all the workers working for the same firm.
To put it another way, traditional companies create jobs by hiring people; nanocorps create jobs by buying goods and services.
Coase also pointed out that there is some distinction; one arrangement or the other might be more efficient, depending on the costs of transacting in the market and the inefficiencies of large firms. Perhaps the Peruvians are entrepreneurial because they have particularly harsh pressures against large firms, for example due to government corruption or organized crime.
On to the issue of “big investments”.
The number of jobs created is largely a function of the amount of value produced by the capital investments in question, and so the number of jobs created per dollar of credit is largely a function of the IRR of those investments, modulo the effects of inequality in distribution. If US$1000 of investment increases workers’ productivity by US$1000 per year, it creates some number of jobs; but that number is likely to be more or less the same whether it is increasing 20 entrepreneurs’ income by US$50 per year each (some of which they can spend on inputs such as cellphone minutes, electricity, wool, or wood, creating jobs in those industries) or whether it is increasing a factory’s income by US$1000 per year (in which case it might do the same, or it might hire another worker or three).
The high (not to say usurious) interest rates of the microcredit loans in question, coupled with their low default rates, are strong evidence that the internal rate of return on these small investments is fairly high. Most of those loans are probably good choices for the people who receive them, I believe, or microcredit would have a serious image problem. (Journalists love nothing more than unmasking hypocrisy.)
There is no principled reason to think that in general, large capital investments will have high IRRs that are systematically unavailable to small capital investments. This kind of thing depends greatly on the technology available.
There are probably some big investments that are worthwhile.