Twofish's Blog

November 29, 2006

Notes on microcredit in China

Filed under: china, finance — twofish @ 7:50 am

Some notes regarding microcredit in China in response to an article in ChinaLawBlog.

http://www.chinalawblog.com/chinalawblog/2006/11/microcredit_in_.html

I’m very dubious of one size fits all solutions and silver bullets, and I’m also dubious of the “bad official” explanation of things.  OK, the official wants to keep his job and maximize his income.  Why does he have to block project X to keep his job and maximize his income?

It seems to me that microcredit doesn’t solve the essential problem of the Chinese peasantry. In contrast to much of the rest of the developing world, Chinese peasants have land use rights which gives them exclusive right to generate income from a piece of land which gives them enough money for subsistence and some extra that they are saving. Also in contrast to much of the rest of the world, Chinese peasants have access to informal sources of capital to start businesses, and I’ve never heard of lack of capital being a major problem in starting a business (expanding businesses is another story).

The trouble is that the Chinese peasant has much of his or her savings locked up because they do not have pension benefits or health insurance or access to funds for education. In this situation, I don’t see microcredit making much of a difference, because the peasant has the money in the bank, it’s just that they can’t use it because they need it when they get sick or get old. Having some form of health insurance and government funding of education would make a lot larger difference since it would allow the peasants to free up income that they already have. Insurance in particular would be helpful because the current method of having everyone save up huge amounts of money in reserve is not very efficient.

The other point is why the government is careful not to endorse microcredit initiatives. Again, the issue that there is large amounts of cash in the countryside. The problem (which happened in the early 1990’s) is that people deposited this cash into an institution thinking that the government was insuring the deposit. The institution then got into trouble loaning money to the wrong people, leaving the peasants and the government with a big mess. This is probably why microcredit agencies are allowed to lend, but not to accept deposits.

The basic issue that I think faces the Chinese peasantry is not access to credit, but rather access to places to *save* their money that results in save, reasonable returns. This decreases the amount they need to save for retirement. Also there needs to be some access to health insurance and public goods like education, which decreases the amount needed to save for these things. Once that is done, I think you’ll find more than enough capital getting unlocked.

Also the idea that the government just doesn’t want independent financial institutions in rural China is a bit misplaced, since any financial institution in rural China is not going to be independent for very long. The fear I think is that the well-meaning microcredit agencies will set up shop in rural China, get “captured” by the local officials which then take deposits from peasants and rechannel them into dubious ventures, and when it all falls apart, there is a mess for the central government to clean up. This is *exactly* what happened with rural financial institutions in the early 1990’s, and there still is a $150 billion mess that remains to be cleaned up. (This mess got second priority after the $350 billion mess in the state commercial banks.)

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