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Aid vs Trade: A Solution for Microfinance in Africa?

Published on December 21, 2010

by Fatima Kourouma

I was recently having a debate with some friends about which is best for Africa’s development: trade or aid. This is an ongoing debate in different forums on the continent where arguments for both positions are presented. When it comes to microfinance in general, the debate is more akin to social vs commercial, or profit vs nonprofit. In discussing microfinance in Africa specifically, it can be interesting to phrase this debate in the aid vs trade framework.

The Debate

The pro-trade believe that Africa needs business relationships with partners and sustainable businesses on the continent in order to support its development. This group, represented by the Zambian economist Dambisa Moyo, argues that trade driven by profit will create the right incentive for market forces to generate growth on the continent. She argues in her bestselling book “Dead Aid” that Western assistance has given rise to a dependency culture in developing countries. However, pro-aid, represented by aid organizations and some celebrities such as Bono of U2, think that aid is needed to support development on the continent because there is not enough infrastructure for business. They argue that the continent is lacking the capital, the entrepreneurs and the structure to grow through businesses. Furthermore, they believe that businesses will focus on urban areas and the disadvantaged rural areas will be left out.

I believe there is a middle ground between these two extremes. There are certainly some areas such as education, health and energy where aid can help a lot. These areas are needed to ensure the basic needs of the population. They support other development areas of the community. For example, a healthy and educated population is more likely to create businesses that can support its growth. The investment requirement in these areas is huge, and the financial return can take longer and is uncertain. There might not be enough incentives for a profit-seeking approach to work. In other areas of  development, where financial return is more certain and represents an incentive for businesses, aid represents a big disincentive and would create an environment in which fair competition is not possible. Working in the microfinance industry, I can’t help but wondering if microfinance falls within the area of aid or trade.  Is trade or aid better for microfinance in Africa?

The Right Approach for Microfinance in Africa

Here are my thoughts. Providing financial services to the poor can be a very profitable business. Many for-profit private companies are already operating in the space. We can therefore argue that “trade” should be encouraged in microfinance instead of “aid.” However, access to financial services is a basic need in certain communities. It has a real uplifting effect on the people, in the same way as education does. Furthermore, in some poor, especially hard to reach communities, there is no business incentive to provide access to financial services because of the cost of servicing these communities. Aid is therefore needed to jumpstart the process.

There are currently many donors fulfilling this need. Without them it would be very difficult for many microfinance ventures servicing poor communities to operate. Donors and other supporters of the microfinance industry also provide microfinance institutions with capacity building opportunities to be able to effectively serve their customers. However, as institutions mature, there is a need to move into a for-profit business model in order to ensure sustainability. Market forces should be allowed to play a role. In the right market environment, the best performers will be able to develop better services and serve more customers while the ineffective ones will disappear. Continuing to support ineffective institution through aid will distort the forces of competition and ultimately be a disservice to the greater microfinance community. This is therefore not a question of aid or trade, but what is the appropriate role for each.

The Role of Transparency

Pricing transparency is critical in ensuring effective competition both in the support phases involving aid and the sustainability phase with more of a “trade” focus. MFTransparency’s Transparent Pricing Initiatives throughout the world train institutions on interest rates and provide tools for understanding pricing to those institutions who did not have such knowledge before. Informed institutions are much more likely to be transparent institutions. Pricing transparency empowers customers as well, allowing them to select the best performing institutions from the non-performing ones. Pricing transparency is a key force in enabling fair competition whether the African microfinance industry is supported through aid or trade.

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