Nobel Peace Prize 2006
By ET
is given to Muhammad Yunus and Grameen Bank for their efforts to create economic and social development from below.
In the press release from sweden:
Loans to poor people without any financial security had appeared to be an impossible idea. From modest beginnings three decades ago, Yunus has, first and foremost through Grameen Bank, developed micro-credit into an ever more important instrument in the struggle against poverty. Grameen Bank has been a source of ideas and models for the many institutions in the field of micro-credit that have sprung up around the world.
The fundamental idea of this micro-credit mechanism is actually quite intriguing from the perspective of economics.
First of all, it puts trust into people who have no ways to show their trustworthiness. This demands a great leap of faith in people. In general financing situations, the lending party uses all kinds of means to ensure that when anything goes wrong, the borrowing party is liable and can be hold responsible for the problem. Usually, the borrowing party has to put his/her assets (house, business or other valuable financial assets like bonds, etc.) down. When the borrowing party does not own anything, a collateral is needed to take up the responsibility. However, in poor economies, a collateral is not so easy to find. Not only it is implausible for individuals to take up all the risk of financing people who own nothing, but these poorest people seldom know any one who are able to offer the help. In a perfectly rational system, offering loans to these people is simply impossible, as there is obvious benefit for people to borrow money, but the cost (at least monetary cost) too them is minimal. Even with a strong legal system, it is simply not economically viable for the banks to loan to these people — suppose you can put anyone who can not repay to jail, the bank still lose the money. This is why I was so amazed to learn about this mechanism when I first read about the idea of the Grameen Bank (from an article written by Jean-Jacques Laffont: Laffont, Jean-Jacques, 2003. “Collusion and group lending with adverse selection,” Journal of Development Economics, Elsevier, vol. 70(2), pages 329-348, April.)
The major consequence of not being able to offer loans to these people is that a great amount of social welfare can not be realized. These people not owning any assets does not mean they do not possess the ability to create social value. Given enough startup funds (and in the cases for the poor, usually not much is needed), they can generate enterprise that may benefit others and most importantly of all, may sustain themselves and their families. People often attribute the power of the small and medium enterprises and the sustainable development of the developed economies to the availability of financial support from loans and venture capitals. Without the $100,000 check written by Larry Ellison on the breakfast table for Google, we will not be able to use the wonderful services now. There are so many examples to show the importance of financing the “talented but poor”.
The Grameen Bank idea implements incentive mechanisms to ensure the repayments in an innovative way. The basic idea is to offer group-lending contracts with joint liability. Traditionally, the role of taking care of the poor lies in the governments, there are many setbacks associated with this appoach. Inefficiency, corruption, mis-management, etc. are not the focus of this article. The point is that centralized decision-making, though theoretically interesting, does not function so well in the real world. The value of Grameen Bank lies in the possibility to use market-based forces to help the poor.
For more information about this, please refer to Wikipedia entry at http://en.wikipedia.org/wiki/Grameen_Bank
