Practically everyone has heard the proverbial story of poor a Bangladeshi or Nigerian taking out a microloan to, say, buy a few chickens or start a small business selling mangoes, and becoming a wealthy and successful farm entrepreneur or fruit trade mogul. There is even a picture book for children about that story.

Picture books, however, don’t make the story any more real or representative. This blog has been critical of microfinance success stories in the past, because they mislead people into generalising from a few exceptional success cases (see also Tim Ogden’s smart analysis of the consequences of misleading storytelling). More generally, the blog has been critical of microfinance because not everyone who takes a loan can make a profit on a business venture and use the profit to repay the loan plus interest; very few will benefit spectacularly from this, and their successes do not equal “development”.

But donor bodies increasingly expect microfinance to become the centerpiece of development. Proposals for microfinance to reach beyond small-business-lending and into the traditional remits of the state abound. Microcredit loans are being suggested and applied by various agencies for generating access to a range of goods and services linked to development, from sending kids to school, creating better health, improving water and sanitation, to even helping with peace and reconciliation. Using microfinance for water and sanitation has been an area of particular focus (here is one prominent example, with its own success stories).

But education, healthcare, water, law and order, etc…, are usually provided by public bodies, or at least strongly regulated and funded by them – especially in all successfully developed countries. Why then is microfinance suggested as a tool for the expansion of these goods and services? And can microfinance really achieve a better supply of these essentials? These are the questions I address in a paper presented in March at the University of Pula, in which I cast an eye onto projects using microfinance for water and sanitation.

To begin with, I trace the political economy of microfinance and problematise the way in which the goods involved are conceived of by advocates of such projects. I find that

The central premise held by advocates of microfinance solutions is that small loans from private MFIs can and will, given the appropriate programme design, act as a substitute for the commitment of the public sector. MFIs are expected to realise the profit opportunities presented by specialised loans for education, health or water and sanitation, and the borrowers, on the other hand, are to grasp these loans as an entrepreneurial opportunity for the betterment of their livelihoods. Given the tangibility and immediate observability of the resources involved, water and sanitation can be understood as a crucial case for testing the assertion that, in developing countries, tiny loans to households can be a means for providing and governing public goods – goods which in richer country contexts are provided and/or strongly regulated by the public sector.

While water and sanitation are not straight public goods per se, “the non-private characteristics of the resources involved confound a simple market-oriented approach as is usually taken by advocates of microfinance for household water and sanitation”. The crux is that water and sanitation systems are dependent on, and in turn affect, common pool resources, such as aquifers, surface water bodies, local environmental quality and public health levels. Even water in a piped system is a common pool resource which must be distributed and divided up in some way. Common pool resources require collective action, not private credit, to ensure their sustainable and inclusive governance.

Furthermore, water and sanitation systems have network characteristics and economies of scale which make it unreasonable to serve one household while excluding another. While individual microloans may provide some households with sufficient finance to buy their way into existing access water and sanitation systems, we have no reason to expect microcredit to help to create such systems in the first place. The bottom line is: without the collective elements of water supply (like mains pipes and treatment plants), what good can microloans do?

There is also the issue of fairness: it seems wrong that such projects expect poor people to pay the full price for connecting to networks plus interest (between 30 and 70 percent in Asia), while water and sanitation are internationally-recognised human rights. But the paper does not make this its main issue.

The predictions of collective action problems and network problems suggested in the paper are corroborated by case analyses from Vietnam and India (Andhra Pradesh). Here, the most pressing problems are found at the systems and local government levels, rather than at the level of household access to finance. This leads to the conclusion that

On the whole, it appears that microfinance for water and sanitation tackles symptoms, not causes, of the underprovision of water and sanitation to the poor. These causes would have to be located in larger collective failures (such as public sector capacity) and unequal access rights ultimately stemming from inequitable social relations and an increasingly unequal ownership of the means of production … It almost appears as if the one element not missing was household access to loans.

If we really care for extending access to the basics of a healthy and fulfilled life, including sufficient water and sanitation, education or healthcare, we would do better to learn from developed country successes which were based on functioning public sectors, instead of seeking to devise private credit-driven makeshift solutions.

Article also published on the Social Science Research Network.